Brighton Perspective

Correction?

The recent market downturn is cause to wonder if we're in the early stages of a market correction. As we entered the year, investors were looking for 26% earnings growth from S&P 500 constituents while economists were looking for 3% GDP growth (consensus). Per Dave Rosenberg, at Gluskin-Sheff, 65% of the companies have reported and, ex Financials, earnings growth has been 16% while gross revenue growth has been 2%. These results should cause investors to rethink their 2010 earnings expectations and price equities accordingly.

Weekly Update

The Markets                            The down draft continued for the first week of February as investors continued to parse the economic data for true signs of recovery. Personal income and spending increased slightly in December which was a positive but the growth was not enough to dispel concerns about the consumer contribution to the recovery. In fact, consumer credit fell again further suggesting that consumers will not be contributing significantly to the recovery any time soon. Finally, unemployment dropped below 10% in the latest report, but investors noted the significant increase in discouraged workers underlying the drop.   Market/Index 2009 Close Prior Week As of 02/06/10 Week Change YTD Change DJIA 10428.05 10067.33 10012.23 (0.55)% (3.99)% S&P 500 1115.10 1073.87 1066.19 (0.72)% (4.39)% MSCI World 1168.47 1119.64 1095.48 (2.15)% (6.25)% Russell 2000 625.39 602.04 592.98 (1.50)% (6.38)% Fed. Funds .25% .25% .25% 0 bps 0 bps 10-year Treasuries 3.84% 3.61 3.59 (2) bps (25) bps Last Week's Headlines ·         Personal income and spending increased in December. Personal income was slightly above expectations while spending was slightly below expectations. ·         Construction spending declined more than expected. ·         Initial jobless claims increased more than expected. ·         Unemployment declined to 9.7% which was better than expected but the number of discouraged workers (not counted as unemployed) surged.   Upcoming Items of Interest ·         The coming week brings an update on Wholesale inventories (Tuesday), January Treasury budget (Thursday), January retail sales (Thursday), Business inventories (Friday) and the Michigan consumer sentiment index (Friday). Of course, we’ll have the on-going issues with Greece and the potential impact of a default or bail-out on the European Union and the Euro.    Data source: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Headlines and upcoming items of interest are pulled from published reports of Vanguard, Briefing.com and Reuters. Past performance is no guarantee of future results. The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The MSCI World Index is a free-float adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.

Weekly Update

The Markets                            Financial markets were down again for the week closing January down uniformly. While the vast majority of companies met or exceeded earnings estimates for the fourth quarter and full year 2009, many did so without demonstrating meaningful top line revenue growth. At one point, aggregate gross revenue growth, x financials, was 0%, even as net earnings growth was in low double digits. Investors appear to be shifting from emphasizing reported earnings growth to top line growth as evidence of true economic recovery. GDP reported on Friday was superficially positive at 5.7% but upon further review demonstrated that most of the growth was via inventory reduction and not from much needed corporate and consumer spending. Fasten your seatbelts!   Market/Index 2009 Close Prior Week As of 01/29/10 Week Change YTD Change DJIA 10428.05 10172.98 10067.33 (1.04)% (3.46)% S&P 500 1115.10 1091.76 1073.87 (1.64)% (3.70)% MSCI World 1168.47 1149.89 1119.64 (2.64)% (4.19)% Russell 2000 625.39 617.12 602.04 (2.44)% (4.95)% Fed. Funds .25% .25% .25% 0 bps 0 bps 10-year Treasuries 3.84% 3.62 3.61 (1) bps (23) bps Last Week's Headlines ·         On Wednesday, the FOMC stated it would continue to maintain the Fed Funds rate at 0.25% for an “extended period”. ·         GDP grew at 5.7% annualized for the fourth quarter of 2009. ·         Durable-goods order increased (positive) but less than expected (negative). ·         Both existing and new home sales declined for December – both declines were unexpected. ·         Consumer confidence increased slightly to its highest level since September 2008.   Upcoming Items of Interest ·         Personal Income, construction spending and manufacturing activity all reported on Monday, the ISM non-manufacturing report on Wednesday, productivity and factory orders on Thursday and employment and consumer credit on Friday. We’ll also hear from the White House regarding the 2011 Federal budget. Expect continued coverage of the financial crisis in Greece and its effect on the European Union.    Data source: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Headlines and upcoming items of interest are pulled from published reports of Vanguard, Briefing.com and Reuters. Past performance is no guarantee of future results. The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The MSCI World Index is a free-float adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.

Earnings: Why Solid Earnings Aren't Good Enough for Fickle Investors - CNBC

Earnings: Why Solid Earnings Aren't Good Enough for Fickle Investors - CNBC.

Missing the point here (though the manager of the Palantir Fund does appear to get it) - my belief is that market participants are not seeing the top line growth necessary to make earnings growth sustainable. Earnings growth exceeding estimates is nice but when the growth is driven by cost containment it is not sustainable. So investors are recognizing that expectations for forward earnings growth are unsustainable and adjusting prices accordingly.

A recent analysis by David Rosenberg showed that after stripping out financials from the 20% of companies that had reported, top line growth year over year was 0%. That should not surprising in light of economic performance over the past year. It also should engender concerns regarding the ability of companies to continue to grow going forward. You can only squeeze so much blood from a stone.

Weekly Update

The Markets                            Financial markets were down sharply on the week. Markets were down Wednesday, Thursday and Friday on continued uncertainty regarding potential regulatory changes and the possibility of restrictions on financial institution activity. Added to this uncertainty was mixed earnings announcements from the corporate sector as earnings season continues and the distinct possibility that Bernanke would not be renamed Fed Chairman. By week’s end, investors were increasingly concerned that the nascent economic recovery was under pressure with many pundits calling for a potential “double-dip”.   Market/Index 2009 Close Prior Week As of 01/22/10 Week Change YTD Change DJIA 10428.05 10609.05 10172.98 (4.11)% (2.79)% S&P 500 1115.10 1136.03 1091.76 (3.90)% (2.09)% MSCI World 1168.47 1198.22 1149.89 (3.83)% (0.81)% Russell 2000 625.39 637.96 617.12 (3.27)% (2.57)% Fed. Funds .25% .25% .25% 0 bps 0 bps 10-year Treasuries 3.84% 3.68% 3.62% (6) bps (22) bps Last Week's Headlines ·      New housing starts fell by 4% surprising analysts expecting an increase ·         Conference Board Index of Leading Indicators increased for the ninth consecutive month ·         Producer prices increased 0.2% for the month and 4.4% for the year, due mainly to increasing energy prices   Upcoming Items of Interest ·         Continued earnings announcements for 4Q09 and calendar year 2009 ·         Fed announcement on short term rates on Wednesday ·         4Q GDP announced on Friday ·         Existing home sales on Monday, consumer confidence on Tuesday, new home sales on Wednesday, durable goods orders on Thursday and employment cost index on Friday    Data source: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Headlines and upcoming items of interest are pulled from published reports of Vanguard, Briefing.com and Reuters. Past performance is no guarantee of future results. The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The MSCI World Index is a free-float adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.

Senate Vote on Fed Chairman Likely to Be 'Very Close': Aide - CNBC

Senate Vote on Fed Chairman Likely to Be 'Very Close': Aide - CNBC.

There are plenty of reasons to remain skeptical of market valuations and of market and economic expectations for 2010. However, this potential event is, for me, at the top. I've said repeatedly over the past year that Bernanke's actions at the Fed were the only positive actions any branch of the government has taken to counter the credit crisis and the recession.

So, for getting things right, while others get things wrong (think Geithner), Bernanke's possibly on the way out. Combine this with overly optimistic earnings growth expectations and a White House push for further financial institutions regulations, which will likely prove ineffective and counter-productive, and you have enough evidence to expect a market correction. Market participants despise uncertainty more than anything and that is about all we have right now.

Jim Cramer thinks a 1,000 point correction (I'm assuming for the Dow), which would be another 10% (on top of the 5% from this week). I've thought for several months a 15-20% correction would occur in 2010 and that seems more and more likely now.

Obama Calls for Limiting Size, Risk Taking of Banks (Update2) - Bloomberg.com

Obama Calls for Limiting Size, Risk Taking of Banks (Update2) - Bloomberg.com.

I've stated before that what the financial markets need is not more regulatory oversight or more unnecessary regulation. Forced fragmentation is unlikely to help improve the financial markets or the economy. Better enforcement of the existing rules and regs by the appropriate regulatory authorities is more likely to be effective.

The market reaction suggests participants are in agreement. Right now, the focus should be on improving regulatory and fiscal clarity for businesses. This lack of visibility is a primary contributor to the "jobless recovery". Put it in context of an individual - if you're not sure if you're going to have to pay more taxes or if you're going to get a raise, you're going to be cautious about spending money. Companies are not going to hire if management believes costs are going to rise and/or growth prospects are going to be restricted.

As long as this uncertainty exists it is going to be difficult to reconcile 26% earnings growth expectations with 3% GPD growth expectations.

Weekly Update

The Markets   Equity markets held up well despite news that wasn’t quite as strong as investors had expected. All major indexes opened 2010 on a positive note advancing more than 1% and in many cases more than 2% for the week. The underwhelming jobs data helped push down the 10 year yield as it fell slightly. Fed meeting minutes also highlighted the fragility of the economic recovery.       Market/Index 2009 Close Prior Week As of 01/08/10 Week Change YTD Change DJIA 10428.05 10428.05 10618.19 1.82% 1.82% S&P 500 1115.10 1115.10 1144.98 2.68% 2.68% MSCI World 1168.47 1168.47 1198.26 2.55% 2.55% Russell 2000 625.39 625.39 644.56 1.76% 1.76% Fed. Funds .25% .25% .25% 0 bps 0 bps 10-year Treasuries 3.84% 3.84% 3.83% (1 bp) (1 bp) Last Week's Headlines ·      Non-farm payrolls dropped by 85,000 which was much more than expected. ·         Consumer credit declined by $17.5 billion in November, an 8.1% decline which was the largest since 1980. ·         The ISM Purchasing index reached its highest level since early 2006. ·         Factory orders increased more than expected. ·         Construction spending declined more than expected.   Upcoming Items of Interest   This week brings the Fed Beige Book on Wednesday, jobless claims, retail sales and business inventories on Thursday and the CPI and industrial production data on Friday. It is also the start to 4Q09 earnings season with Alcoa up first.    Data source: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Headlines and upcoming items of interest are pulled from published reports of Vanguard, Briefing.com and Reuters. Past performance is no guarantee of future results. The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The MSCI World Index is a free-float adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.

Weekly Update

The Markets   Equity markets turned down during the final, holiday-shortened, week of the year but that didn’t dampen the enthusiasm building for 2010. The indexes all finished 2009 much higher than where they began the year showing remarkable resiliency. The breadth of the 9 month long rally was impressive as well as the Dow, the S&P, The World, and the Russell 2000 all posted healthy gains. Of some interest was the rather significant increase in 10 year T-bond yields over the last month. Yields had reached 3.94% in June before gradually falling to 3.20% on November 30. The year closed with yields at 3.84%. It will be interesting to see if this plays out as a signal of market expectations for higher inflation, as a risk premium for owning more U.S. Government debt or simply part of the sine wave we’ve seen in yields since early June.     Market/Index 2008 Close Prior Week As of 12/31/09 Week Change YTD Change DJIA 8776.39 10520.10 10428.05 (0.88)% 18.82% S&P 500 903.25 1126.48 1115.10 (0.01)% 24.71% MSCI World 920.226 1171.56 1168.47 (0.26)% 26.98% Russell 2000 499.45 634.07 625.39 (1.37)% 25.22% Fed. Funds .25% .25% .25% 0 bps 0 bps 10-year Treasuries 2.24% 3.81% 3.84% 3 bps 150 bps Last Week's Headlines ·      Consumer confidence was slightly higher than expected as reported by the Conference Board on 12/29. ·        Initial Jobless claims were well below expectations.   Upcoming Items of Interest   The new year enters with a busy week of reporting. We get the latest ISM reports for manufacturing activity (Monday) and service-sector activity (Wednesday), construction spending (Monday), factory orders (Tuesday), FOMC meeting minutes (Wednesday) and, on Friday, unemployment rate, payroll and consumer credit. We’ll also hear throughout the week about the strength of the Christmas retailing season. This will be important to participants as a gauge of consumer sentiment. Early reports are that consumers were spending more than expected and that should be a sign of optimism for 2010.  Data source: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Headlines and upcoming items of interest are pulled from published reports of Vanguard, Briefing.com and Reuters. Past performance is no guarantee of future results. The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The MSCI World Index is a free-float adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.

Weekly Update

The Markets   The economic news last week was generally positive but market performance suggests these results were already priced in. Equity markets mostly declined last week (with small cap the exception) while bond yields held steady. While the Fed acknowledged the improving economy, it continued to hold the short-term interest rate (Fed Funds rate) steady and suggested it will do so for “an extended period.” The Conference Board’s index of leading indicators was up again for the eighth consecutive month (and exceeded expectations). The current level is higher than the previous peak in July of 07, but the Board noted that growth was slowing. Prices increased at both the producer and consumer levels, both driven by increasing energy prices. This is something to watch as recent declining prices (measured by the PPI and CPI) have been driven mostly by declining energy prices. If energy has found a bottom we may be seeing the first signs of an uptick in inflation.   Market/Index 2008 Close Prior Week As of 12/18/09 Week Change YTD Change DJIA 8776.39 10471.50 10328.89 (1.36)% 17.69% S&P 500 903.25 1106.41 1102.47 (0.36)% 22.06% MSCI World 920.226 1155.54 1144.11 (0.99)% 24.33% Russell 2000 499.45 600.37 610.57 1.70% 22.25% Fed. Funds .25% .25% .25% 0 bps 0 bps 10-year Treasuries 2.24% 3.38% 3.54% 0 bps 130 bps Last Week's Headlines ·      Federal Reserve holds rates steady and indicates it will do so for an “extended period”. ·        PPI increases 1.8%, greater than expectations, driven by increasing energy and food prices. ·        Industrial production increases and exceeds expectations. ·        New construction starts were below expectations. ·        Initial jobless claims exceeded expectations   Upcoming Items of Interest   The holiday week will bring light news and light trading markets. We’ll see GDP and existing home sales on Tuesday, new home sales and personal income on Wednesday and durable goods on Thursday. Markets are closed on Friday.   Data source: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Headlines and upcoming items of interest are pulled from published reports of Vanguard, Briefing.com and Reuters. Past performance is no guarantee of future results. The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The MSCI World Index is a free-float adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.

Weekly Update

The Markets   Economic news was light this week but what was released was generally positive and lead to modest gains in domestic large cap stocks. Small cap stocks declined slightly as did global equities. International stocks were likely impacted by the continuing Dubai issues as investors reassessed their perception of risk priced into these securities. The small cap decline was very modest and, while it would be nice to believe it’s indicative of a rotation away from lower quality stocks, was probably more indicative of investors locking in gains prior to year-end.   Market/Index 2008 Close Prior Week As of 12/11/09 Week Change YTD Change DJIA 8776.39 10388.90 10471.50 0.80% 19.31% S&P 500 903.25 1105.62 1106.41 0.04% 22.49% MSCI World 920.226 1168.90 1155.54 (1.14)% 25.57% Russell 2000 499.45 602.78 600.37 (0.36)% 20.21% Fed. Funds .25% .25% .25% 0 bps 0 bps 10-year Treasuries 2.24% 3.38% 3.54% 16 bps 130 bps Last Week's Headlines ·      Consumer credit outstanding declined by $3.5 billion, which was good, but was less than expected. Consumers are spending but remain unlikely to be drivers of economic recovery. ·        Retail sales were up, more evidence that consumers are spending. ·        Business inventories increased which is a potential sign that the private sector is becoming more optimistic. ·        The trade deficit declined as the weak dollar fueled higher exports. While still negative, a declining deficit is a good sign. Upcoming Items of Interest   The upcoming week will see bring the latest producer price index reading as well as the latest industrial production reading. Both are expected to increase modestly. We’ll also get the latest CPI reading which is also expected to increase modestly. Finally, we’ll get the latest Leading Indicators reading which is expected to rise as well. Data source: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Headlines and upcoming items of interest are pulled from published reports of Vanguard, Briefing.com and Reuters. Past performance is no guarantee of future results. The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The MSCI World Index is a free-float adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.

Weekly Update

The Markets   Equity markets advanced on the week on mostly better than expected positive news from the global economies. Investors also adjusted their outlook regarding Dubai World as the Dubai government denied there was any explicit government backing and Abu Dhabi stepped in to pick up some of the loans. The perceived net result is that this was not the pebble which would cause the next global debt crisis. By the end of the week, concerns were increasing regarding the strength of the economic recovery in the U.S. and the increasing U.S. government debt burden. Market/Index 2008 Close Prior Week As of 12/4/09 Week Change YTD Change DJIA 8776.39 10309.92 10388.90 0.77% 18.37% S&P 500 903.25 1091.49 1105.62 1.29% 22.40% MSCI World 920.226 1144.58 1168.90 2.12% 27.02% Russell 2000 499.45 577.21 588.41 1.94 17.81% Fed. Funds .25% .25% .25% 0 bps 0 bps 10-year Treasuries 2.24% 3.21% 3.38% 17 bps 114 bps Last Week's Headlines ·      Chicago PMI reading was 56.1 which was better than forecast indicating a recovering economy. ·        Construction spending and new home sales both improved and were better than expected. ·        The ADP employment report, initial and continuing claims were all better than expected. ·        The unemployment rate declined to 10%, better than expected, though it continues to remain very high. ·        Factory orders increased and were better than expected.   Upcoming Items of Interest   The upcoming week will see investors watching the latest consumer credit numbers. A decline in outstanding consumer debt is expected as consumers continue to improve their personal balance sheets. We’ll also see weekly initial jobless claims, the trade balance, Treasury budget, retail sales and preliminary November Michigan consumer sentiment index reading.    Data source: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Headlines and upcoming items of interest are pulled from published reports of Vanguard, Briefing.com and Reuters. Past performance is no guarantee of future results. The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The MSCI World Index is a free-float adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.

Options Signal Stock Peril as Analysts See Profits (Update2) - Bloomberg.com

Options Signal Stock Peril as Analysts See Profits (Update2) - Bloomberg.com.

More of the same. Note the previous high was in 1999 just prior to an extended 3 year downturn in the equity markets. Managing risk is a critical component to long-term investment management success. To me that involves discounting excessive optimism and pessimism. Discount the current optimism and consider whether hedged equity and/or market neutral strategies may make sense for your portfolio.

Bernanke Sees ‘Formidable Headwinds’ for Economy, Tight Credit - Bloomberg.com

Bernanke Sees ‘Formidable Headwinds’ for Economy, Tight Credit - Bloomberg.com.

The equity markets are still looking for net earnings growth around 30% for 2010. Yet, there is mounting evidence that such an optimistic outlook is unwarranted. Growth in net earnings generally comes from some combination of two sources - reduction in expenses and top-line revenue growth. Companies have improved cost containment rather successfully over the last 12 months such that average EBITDA margins are close to 32% vs a 50 year historical average of 28%. It would appear that future improvements will be marginal. Thus, top line growth would appear to be the primary driver of significant earnings growth.

However, the comments by Bernanke in this article lend credence to bond market participants outlook which is much more sanguine about future growth. If consumers cannot access debt markets and are concerned about losing their jobs or are already unemployed, spending is unlikely to materially increase. Without a significant boost in consumer spending, top-line revenue growth is unlikely to be strong enough to support 30% earnings growth expectations.

Consequently, I still believe the S&P 500 will find its way to 950 before 2010 is over. I called for 950 as the ending value for 2009 which is unlikely now. I certainly wouldn't want a 18%+ correction in the next 15 trading days! But, at some point economic realities will clash with market optimism.

Weekly Update

The Markets   Equity markets very modestly positive through Wednesday ahead of the Thanksgiving Day holiday here in the U.S. Then, on Wednesday, Dubai World announced it would seek a six month reprieve on its debt. The fear of another massive liquidity crunch driven by sovereign debt default caused a global sell-off. The S&P 500 gapped down 25 points (more than 2%) on the open Friday and recovered only slightly on the day to end the week flat to slightly down. This news should create a bit of an overhang until investors more fully understand the potential global consequences and adjust prices accordingly. Many skeptics have been searching for the “correction” trigger and a potential sovereign default, if not contained, could be it. Market participants will monitor this one closely. Market/Index 2008 Close Prior Week As of 11/27/09 Week Change YTD Change DJIA 8776.39 10318.16 10309.92 (0.01)% 17.47% S&P 500 903.25 1091.38 1091.49 0.00% 20.84% MSCI World 920.226 1145.72 1144.58 (0.01)% 24.38% Russell 2000 499.45 584.68 577.21 (1.03)% 15.57% Fed. Funds .25% .25% .25% 0 bps 0 bps 10-year Treasuries 2.24% 3.36% 3.21% (15) bps 97 bps Last Week's Headlines ·      Existing home sales exceeded expectations ·        Consumer confidence index exceeded expectations ·        Estimates for October personal income and personal spending were higher than expected ·        Initial and continuing unemployment claims were below expectations ·        Durable goods orders fell and were below expectations ·        Michigan Sentiment Index was revised upward beating expectations ·        New home sales for October beat expectations     Upcoming Items of Interest   The focus this week will be on Dubai and the potential negative effects the issues surrounding Dubai will have on global markets. Domestically, the focus will be on the Chicago PMI index, the Fed Beige Book and employment statistics – initial and continuing unemployment claims and non-farm payrolls. Obviously, looking for more evidence of economic recovery.   Data source: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Headlines and upcoming items of interest are pulled from published reports of Vanguard, Briefing.com and Reuters. Past performance is no guarantee of future results. The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The MSCI World Index is a free-float adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.

Various Thoughts

While catching up on my reading over the weekend and this morning several thoughts came to mind (it does happen from time to time):

1) It seems to me that market performance over the last quarter has been driven by the weakening dollar rather than by expectations for economic performance. That is equity market performance has been driven by liquidity rather than fundamentals (someone else's phrase but fitting just the same). This is disconcerting as it suggests to me that a real correction is possible - greater than the 10-15% or so I have been assuming for awhile. I don't think it will happen in the next 5 weeks, though some suggest a sell-off is possible in late December as active investors lock in gains and reduce risk to ensure year-end bonuses. More likely it'll occur in the early part of 2010. I'm a strong advocate for constructing portfolios that are more conservative than an investor's risk tolerance. Such a portfolio pays an "insurance premium" to reduce volatility and hopefully hedge downside risk. If you haven't done so, give this some thought heading into year-end.

2) I went to grad school in the early 90's and Monetarism was favored over Keynesianism. I favor less government and more private enterprise but acknowledge that the government has a role in providing services private participants are unwilling to provide. However, these services should be provided in relationship to the government's ability to pay for them. This link is to a new study by two Harvard economists that finds that "Fiscal stimuli based upon tax cuts are more likely to increase growth than those based upon spending increases. As for fiscal adjustments those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases. In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions." I'm biased in this direction but it is nice to see new evidence that supports tax cuts over spending. Policies favoring increasing spending, increasing debt and increasing taxes are not good for investors. Which leads to point 3.

3)

Source: Mark Perry

The emerging markets, particularly Asia, despite recent equity market run-ups continue to look attractive. As this chart shows the Asian countries have significantly increased their contribution to global GDP and at the expense of the EU15. The dip in the late 90s is likely attributable to the currency crisis in 97 and the Russian default/LTCC debacle in 98. Lessons were learned at that time that helped in 2007-2008. Per the IMF, advanced economics (largely the EU, US, Japan) had a current account balance of (.66)% of GDP for 2009 and are forecast to only reduce that to (0.33)% by 2014. Emerging and developing countries, by comparison, had a current account balance of 2.02% for 2009 and are forecast to increase that to 3.5% by 2014. Additionally, gross national savings for advanced countries is forecast to 17.5% of GDP in 2010 but 33.5% for developing and emerging countries. Stronger balance sheets and higher savings rates lead to improvements in net worth (standard of living) and to better investment returns. Continue to consider emerging markets for your portfolios at the expense of the U.S. and other developed markets. This isn't to say eliminate developed markets just be skeptical of equity market returns in the near term.

Weekly Update

The Markets   Equity markets backed up for the week as mounting data suggested the U.S. recovery, and potentially the global recovery, is going to a long, tough slog. The uncertainty among investors caused a sell-off in equity and positive flows into gold and short-term fixed income. T-bill yields declined to just 0.05% with yields dropping below zero briefly on Thursday. Low interest rates and a declining dollar have enabled equity investors to push prices up and have led to a disconnect between equity and fixed income markets. It appears that equity market participants are more enthusiastic about the recovery than fixed income investors. At some point in the near future, one group will be proven correct. It would appear equity investors are beginning to grow concerned that it won’t be them. Market/Index 2008 Close Prior Week As of 11/20/09 Week Change YTD Change DJIA 8776.39 10270.47 10318.16 0.47% 17.57% S&P 500 903.25 1093.48 1091.38 (0.01)% 20.83% MSCI World 920.226 1158.26 1145.72 (1.08)% 24.50% Russell 2000 499.45 586.26 584.68 (0.27)% 17.06% Fed. Funds .25% .25% .25% 0 bps 0 bps 10-year Treasuries 2.24% 3.45% 3.36% (9) bps 112 bps Last Week's Headlines ·      Leading indicators rose for the seventh consecutive month but only by 0.3%. ·        New home construction fell 10.6% to the lowest level in six month and 30.7% below the pace of one year ago. ·        Core CPI increased only 0.2% suggesting inflation is in check. ·        Industrial production rose for the fourth consecutive month by 0.1% which was less than expected.     Upcoming Items of Interest   Despite a short week, there will be an abundance of economic data reported this week. First up is existing home sales on Monday. Tuesday we’ll see the latest GDP report, consumer confidence and the Federal Open Market Committee meeting minutes. On Wednesday, we’ll get durable-goods orders, personal income and spending, and new home sales. Keep in mind that roughly 70% of GDP is comprised of consumer spending. So the consumer confidence and personal income and spending reports will be important. The other data will highlight the economic recovery. Data source: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Headlines and upcoming items of interest are pulled from published reports of Vanguard, Briefing.com and Reuters. Past performance is no guarantee of future results. The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The MSCI World Index is a free-float adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.

Invest like Paulson?

greatest-trade-how-you-can-make-20-billion: Personal Finance News from Yahoo! Finance.

Most of the "lessons" listed in the article are common sense. A few are worth discussing:

3) Debt Markets can do a better job predicting problems than stock markets. Consider - right now interest rates are very low across the spectrum - see this chart - suggesting subdued economic growth going forward while equity markets are predicting 30% year-over-year earnings growth. This despite average EBITDA margins for the S&P 500 at 32%, 4% over the historical average of 28%. What does that mean? It means there is much left to squeeze from the cost structure so earnings growth must come from top line revenue growth. Essentially the bond markets are suggesting that kind of growth isn't possible right now. Who's right? I don't know but I'm more inclined to believe the debt markets.

5) Don't underestimate the value of a safety net. If the debt markets are correct, the equity markets will likely correct at some point. The safety net will help your portfolio endure that correction. The article suggests put options. For most investors, I'd suggest looking for mutual funds that actively incorporate hedging techniques.

A good article as it highlights common sense investing. Of course, to match Paulson, one also needs softer characteristics such as intuition, courage and and a little bit of luck. We can't all make $20 billion but we can utilize these lessons to improve our own portfolios.

Weekly Update

Financial markets rallied over the last week reversing a two week decline. The Dow was able to hold on to gains and close over 10,000 returning to levels not seen since October 22. Economic news continued to be mixed but was well received by investors looking for any signs of economic recovery strong enough to maintain the equity rally we’ve seen since late March. Yields increased as fixed income investors continue to remain concerned about the decline of the dollar and continued interest among some foreign governments to swap dollars for gold as their currency reserve. Market/Index 2008 Close Prior Week As of 11/06/09 Week Change YTD Change DJIA 8776.39 9712.73 10023.42 3.20% 14.21% S&P 500 903.25 1036.19 1069.30 3.20% 18.38% MSCI World 920.226 1106.170 1132.192 2.35% 23.03% Russell 2000 499.45 562.77 580.35 3.12% 17.71% Fed. Funds .25% .25% .25% 0 bps 0 bps 10-year Treasuries 2.24% 3.39% 3.54% 15 bps 130 bps Last Week's Headlines · Commercial property prices increased for the first time in more than a year based on the latest report from the MIT Center for Real Estate ·  Planned lay-offs fell for the third consecutive month in October according to Chancellor, Gray & Christmas ·  The Fed indicated that it is unlikely to raise rates for an “extended period” ·  Mortgage rates dropped below 5% for the first time in three weeks according to Freddie Mac   Upcoming Items of Interest Markets will be focused on news released over the weekend by the G20 indicating their intentions to continue to support the stimulus measures boosting the global economy. Thursday brings the latest employment news – initial and continuing claims (market consensus is for a slight decline in both), and Friday brings the latest U of Michigan Sentiment Index measuring consumer sentiment (market forecast is for a slight increase). Data source: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Headlines and upcoming items of interest are pulled from published reports of Briefing.com and Reuters. Past performance is no guarantee of future results. The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The MSCI World Index is a free-float adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.

What Should a Financial Advisor Do for You?

I've seen a number of articles lately on the role of the financial advisor. I've also been asked lately where do I think the markets are headed. Both thoughts dovetail nicely I think.

The financial advisor's role is to help protect and build your asset base. You have worked hard over the years to build up a 401k balance, own a nice home and build, hopefully, a taxable investment portfolio as well. You have also tried to save money for college, for retirement and for future generations. You want to retire earlier than your parents did and enjoy the "fruits of your labor". This is where the advisor comes in.

Most of us do not have the ability to forecast the future with precision. Thus, our objective is to forecast as best as possible and hedge the potential risks we expect to encounter along the way. We will attempt to protect your assets via financial and estate planning techniques so that you keep as much as possible of what you have earned and have the best opportunities to pass on a legacy to future generations of your family. A number of risks are encountered in this process - legal and regulatory changes, economic cycles, etc. Not all can be forecast with certainty and the advisor should account for that uncertainty.

With regard to investments, I believe advisors should be focused on constructing portfolios that attempt to meet basic goals - generate an absolute return that exceeds inflation plus a spending percentage and hedge against potential downside risks. These are competing goals and thus require constant examination. Asset allocation is not dead but does need to be revisited conceptually. I believe that rather than regarding asset allocation as an equity/fixed/other combination, advisors should be viewing asset allocation as core-satellite or on a risk basis. The allocation decision is driven by risk targets first, then by return. So the objective is to properly allocate risk among various assets. In this assessment, lower risk strategies are considered core strategies and can be fixed income, equity or other assets. Same goes for riskier assets (satellite). This does involve a degree of tactical asset allocation which involves trading more the riskier assets more frequently. I'm not trying to time the perfect entry and exit, rather, I'm trying to take advantage of volatility to provide excess return when assets are moving up and hedge downside risk when assets are declining. It's not perfect but I think better addresses my primary objectives than the traditional asset allocation approach.

So the financial advisor is attempting to preserve and grow what you've acquired. We should be more conservative than you most of the time and should be the "voice inside your head" attempting to reason you out of more aggressive decisions. We're not perfect, but if we successful one more time than we're not, we should do well for you.

As to where the markets are going, I don't know. I'm always skeptical (never truly a bull or a bear) and always more comfortable with a portfolio that has some "insurance" against a market decline. I think the "premium" paid to hedge some of the downside volatility is worthwhile.

Weekly Update

The Markets   Financial markets were mostly flat for the week as investors took advantage of continued better than expected earnings reports to take profits built up over the past 6 months. Treasury yields moved higher ahead of record note sales planned for the coming week. Economic data was uneventful as chain store sales were slightly positive, consumer sentiment fell slightly, the Fed suggested the economy was stabilizing in some areas and recovering in others and the index of leading indicators improved. Market/Index 2008 Close Prior Week As of 10/18/09 Week Change YTD Change DJIA 8776.39 9995.91 9972.18 -0.24% 13.63% S&P 500 903.25 1087.68 1079.60 -0.11% 19.52% MSCI World 920.226 1170.638 1153.422 -0.02% 26.65% Russell 2000 499.45 616.18 600.86 -2.49% 20.30% Fed. Funds .25% .25% .25% 0 bps 0 bps 10-year Treasuries 2.24% 3.42% 3.48% 6 bps 124 bps Last Week's Headlines ·      Consumer confidence fell suggesting consumer spending will not lead the nascent recovery ·       The index of leading indicators rose for the sixth consecutive month to a 2 year high ·       Sales of previously owned homes improved to a 2 year high     Upcoming Items of Interest Earnings season has ended and investors will now focus on holiday retail sales for evidence that consumers will be contributing to the economic recovery via holiday spending. Investors will also note the 10 year note sales, durable goods orders, GDP growth, jobless claims and personal income and outlays reports. Data source: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Past performance is no guarantee of future results. The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The MSCI World Index is a free-float adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.

Weekly Update

The Markets   Equity markets moved sharply higher during the week thanks to several rounds of positive news including continued better than expected earnings. The weight of the evidence continued to suggest to market participants that the rate of recovery for the economy could support higher equity prices. Market/Index 2008 Close Prior Week As of 10/9/09 Week Change YTD Change DJIA 8776.39 9864.94 9995.91 1.33% 13.90% S&P 500 903.25 1071.49 1087.68 1.51% 20.42% MSCI World 920.226 1139.844 1170.638 2.70% 27.21% Russell 2000 499.45 614.92 616.18 0.20% 23.37% Fed. Funds .25% .25% .25% 0 bps 0 bps 10-year Treasuries 2.24% 3.38% 3.42% 4 bps 118 bps Last Week's Headlines ·       Inflation remained sanguine, up 0.2% in September but down 1.3% from last year. ·       Oil and gold continue to rise while the dollar continued to fall suggesting investors are looking for a dollar alternative. ·       The ISM index rose above 50% for the first time in a year. An index reading over 50 suggests the economy is growing.     Upcoming Items of Interest Earnings reports continue this week along with updates on housing starts, wholesale inflation, leading economic indicators and existing home sales. Earnings will continue to be of particular importance as investors look for top-line growth to improve. Top line improvement could be seen as strong evidence that the economic recovery is sustainable.   Data source: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Past performance is no guarantee of future results. The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The MSCI World Index is a free-float adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.

Risk Appetite Hits Highest Level in Over Three Years - Morningstar - Market Update

Risk Appetite Hits Highest Level in Over Three Years - Morningstar - Market Update.

Mutual fund cash levels have often been used as a contrarian indicator. Cash levels are now at their lowest levels since 2004. That was in the middle of good run that didn't end until 2007. As we've seen many times in financial markets, investors can remain irrational for longer than would seem reasonable.

I agree with most of the sentiments though - I think developed markets x U.S.  are looking more attractive than emerging markets (equity at least) and the U.S. I think the dollar is probably undervalued but don't believe that will change any time soon. Devaluing the dollar is, I believe, part of the government's approach to economic recovery, so not much, if anything, will be done to offer support until the economy's growth appears self-sustaining. At present, that doesn't appear to be the case.

Weekly Update

The Markets   Equity markets moved sharply higher during the week thanks to several rounds of positive news including better than expected earnings from Alcoa, smaller than expected trade deficit, falling mortgage rates and slightly better than expected employment data. The weight of the evidence suggested to market participants that the rate of recovery for the economy could support higher equity prices. Market/Index 2008 Close Prior Week As of 10/9/09 Week Change YTD Change DJIA 8776.39 9487.67 9864.94 3.98% 12.40% S&P 500 903.25 1025.21 1071.49 4.51% 18.63% MSCI World 920.226 1088.903 1139.844 4.68% 23.87% Russell 2000 499.45 580.20 614.92 5.98% 23.12% Fed. Funds .25% .25% .25% 0 bps 0 bps 10-year Treasuries 2.24% 3.22% 3.38% 16 bps 114 bps Last Week's Headlines ·       U.S. mortgage applications surged to highs last seen in May as rates fell to a 4 month low. ·       U.S. trade gap narrowed to $30.7 billion which was roughly 10% lower than expected. ·       The ISM index rose above 50% for the first time in a year. An index reading over 50 suggests the economy is growing.     Upcoming Items of Interest Earnings reports continue this week along with updates on retail sales, business inventories, the consumer price index, jobless claims and consumer sentiment. Earnings will be of particular importance as investors look for top-line growth to improve. Top line improvement could be seen as strong evidence that the economic recovery is sustainable.   Data source: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Past performance is no guarantee of future results. The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The MSCI World Index is a free-float adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.

Rational Expectations

An excellent article in Canada's National Post today by Terrence Corcoran regarding the current dispute between economists such as Krugman & Posner, favoring Keynesian economics, and most everyone else, favoring rational expectations.

The jist of the dispute is that Krugman and Posner believe we need a return to classical Keynesian economics with significant government involvement to ensure that market and economic participants who would not otherwise act "rationally" do so. The rational expectations side argues that participants will act rationally on their own with the information they have at that moment. Given that the information is not perfect, decisions will not always be perfect. Importantly, participants cannot be fooled for acting "rationally" as determined by the government.

To me the argument is for more government involvement because "the government knows best what is good for participants" vs less government involvement because market participants "know best" what is good for them. I'm on the side of participants.

Weekly Update

The Markets

Major equity markets turned south for the week as much of the economic data was negative. The Dow fell 84 points, the S&P 500 fell 12 and NASDAQ fell by almost 18. Not to be left out, the MSCI World index also declined by more than 2%. Overall, not a great week for financial markets worldwide.

Market/Index	2008 Close	Prior Week	As of 10/2/09	Week Change	YTD Change
DJIA	8776.39	9820.20	9487.67	-3.06%	7.66%
S&P 500	903.25	1044.38	1025.21	-1.84%	13.50%
MSCI World	920.226	1115.398	1088.903	-2.38%	18.33%
Russell 2000	499.45	598.94	580.20	-3.13%	16.17%
Fed. Funds	.25%	.25%	.25%	0 bps	0 bps
10-year Treasuries	2.24%	3.33%	3.22%	-11 bps	98 bps

Last Week's Headlines

·       U.S. unemployment hits 9.8%. This was a 26 year high. The drop in payrolls was greater than predicted by economists.

·       U.S. factory orders dropped for the first time since March giving investors additional reasons to wonder if the nascent recovery is sustainable.

·       U.S. consumer spending surged in August likely boosted by the “cash for clunkers” program which expired at the end of August.

·       U.S. 2^nd quarter GDP was revised to a smaller decline than had been forecast by most economists.

 

Upcoming Items of Interest

Light on news this week but a few items of interest will be released. First up is the ISM Non-Manufacturing Index. Investors will be looking for a number greater than 50 which would indicate economic improvement. On Wednesday, the latest data on consumer credit will be announced. Current consensus is for a contraction of approximately $8.5 billion. Outstanding debt has been falling steadily since late 2007.  On Thursday, the latest jobless claims data will be released. Current consensus is 540,000 new claims which would continue a relative decline in claims. The four week average should also show a decline which would be indicative of continued economic recovery.

Data source: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Past performance is no guarantee of future results. The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The MSCI World Index is a free-float adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.

Felix Salmon » Blog Archive » Chart of the day, hours-worked edition | Blogs |

Felix Salmon » Blog Archive » Chart of the day, hours-worked edition | Blogs |.

I'm not overly optimistic about near-term economic growth but the contrarian in me wonders if this is a sign of a bottom. When the media turns negative, the worst is usually over.

I'm still skeptical and do expect a correction before year-end but I don't see the square-root path here. I see a long, slow process of recovery.

Andrew Lo on the wisdom of crowds

FT.com / Markets / Insight - Insight: When the wisdom of crowds becomes the madness of mobs.

I have been a fan of Andrew Lo for a number of years. I appreciate his comments here regarding tactical asset allocation to manage risk. As a proponent of a core/satellite approach to portfolio mangement, this is consistent with my reasoning. The satellite component is comprised of higher volatility strategies which should and are managed tactically. The core is comprised of lower volatility strategies which can be managed strategically. The objective is to manage risk and maximize expected return given the target risk level.

This inverts the traditional approach which focused on maximizing return while attempting to minimize risk given that target return. I think 2008 demonstrated that the traditional approach of relegating risk management to a secondary issue invites rather dramatic draw-downs and is awfully painful to endure. For my clients, and myself, I'd rather give up upside to protect downside through better risk management and a better understanding of risk tolerance. The "insurance" is worth the premium.

Weekly Update

Market Week: September 28, 2009

The Markets The rally took a breather (or possibly a last gasp?) this week. The Dow backed away from the tantalizingly close 10,000 level with a 177-point intraday swing on Wednesday after the Federal Reserve's discussion of its future bond-buying plans. It was largely downhill from there as the major indexes took back much of last week's gains. Market/Index 2008 Close Prior Week As of 9/25/09 Week Change YTD Change DJIA 8776.39 9820.20 9665.19 -1.58% 10.13% NASDAQ 1577.03 2132.86 2090.92 -1.97% 32.59% S&P 500 903.25 1068.30 1044.38 -2.24% 15.62% Russell 2000 499.45 617.88 598.94 -3.07% 19.92% Global Dow 1526.21 1926.12 1884.05 -2.18% 23.45% Fed. Funds .25% .25% .25% 0 bps 0 bps 10-year Treasuries 2.24% 3.47% 3.33% -14 bps 109 bps Last Week's Headlines After four straight months of increases, existing home sales fell 2.7% in August--a sharp drop from July's 7.2% increase. However, the total backlog of unsold homes was down to an 8.5-month inventory. Sales of new homes were essentially flat after four months of increases, and inventories of unsold new homes fell by 3%. As expected, the Fed kept interest rates steady but will extend its purchases of mortgage-backed securities, gradually winding down the program by the end of Q1 2010. However, Fed buying of Treasury bonds, which has helped support that market, will stop at the end of October as previously announced. Leading economic indicators tracked by the Conference Board were up for the fifth month in a row. The major factors in the 0.6% August increase were supplier deliveries, the interest rate spread between 10-year Treasuries and the fed funds rate, and higher stock prices. Only three indicators--real money supply, weekly jobless claims, and new orders for nondefense capital goods--were negative. Five IPOs that began trading on a single day this week and increased filings for more at the SEC gave another indication of renewed appetite for increased risk. Orders for durable goods fell 2.4% in August after a 4.8% increase the month before. A dramatic drop in commercial aircraft orders was responsible for much of the decline. However, even non-transportation-related goods were down slightly after having increased 0.9% in July, and defense-related spending provided much of the support for that figure. Gold had its first weekly loss in six weeks, and well-stocked inventories pushed oil down roughly 8%, the biggest weekly loss since July. The G20 leaders agreed to promote more domestic consumption by export-dominated China and Japan, a lower U.S. budget deficit, increased International Monetary Fund ownership by developing nations, and reforms in bank compensation policies and capital requirements. However, skeptics noted that the so-called global framework for growth lacks any enforcement mechanism. Eye on the Week Ahead Potential window-dressing on the part of large institutional investors could mean volatility in advance of the end of the quarter on Wednesday. Friday's unemployment claims stats are expected to continue to show job losses. Key data releases: Home prices, consumer confidence (9/29); revised Q2 gross domestic product (9/30); auto sales, personal income and spending, manufacturing (10/1); unemployment, nonfarm payrolls (10/2). Data source: Includes data provided by Forefield, Inc. & Brounes & Associates. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Past performance is no guarantee of future results. The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indexes listed are unmanaged and are not available for direct investment.

Cash on the Sidelines?

Whenever markets decline, talk invariably turns to "cash on the sidelines" and the impact it will have when it returns to the markets. Annaly Capital Management has a commentary that shows several charts regarding "cash on the sidelines". The essence is that cash never leaves the sidelines! I would guess that the cash holding is a policy decision and the few investors that do move to all cash at some point during a downturn don't materially impact the aggregate level of cash. This is an interesting chart from Annaly Capital Management:

To me, it highlights clearly the introduction of leverage into the markets in the late 1970s (Milken?!) and the continued increase in leverage until the mid 90s at which point it more or less stabilizes just over 20%. Cash collateral again declines during 2001 (hedge fund boom) and bottoms last year before turning back up, much as it did in 2000 (post interet bubble burst). Clearly, there remains significant leverage in the equity markets. I think the question is will this de-levering trend continue or will we see a reversal as we did in 2001/2002? If market participants continue to de-lever, markets are unlikely to move materially higher - it stands to reason that "un-levered" markets will trend consistent with earnings trends. If leverage isn't reduced, then we could see markets continue to accelerate a rate greater than earnings growth (more dollars translates to greater demand). I don't know the answer but I do think it needs to be an important consideration for any forecasts of future returns.

I expect participants will continue to de-lever in anticipation of potential inflation (which will increase borrowing costs) and because of a desire to improve balance sheets and reduce risk. To what point I don't know, maybe to 25% from roughly 20% now. That would suggest a 25% reduction in debt still to come. That should dampen returns but suggests that we won't see a true 1-1 relationship between financial market growth and earnings growth. In other words, it is possible that we won't see P/Es return to historical averages (such as 15 on the S&P) but rather some level above that.

Currently, the S&P is trading at 19.6X bottom-up 2009 estimates and 14.5X 2010 estimates. P/Es tend to contract after the economy troughs as real results start to meet and exceed expectations upon which prices are set. If P/Es contract to 15 (historical average), the potential year-end 2010 S&P index level would be 1094. I think many would see that as reasonable given the current economic environment of slow improvement in fundamentals. But if leverage doesn't decline as much as people, including me, have expected, the P/E ratio may contract only to, say, 17.3 (50%). Then the S&P might close 2010 at 1262. That would be a roughly 19% gain over the next 15 months. 

I will continue to hedge downside risk but will be paying close attention to the ratio highlighted in the chart above (as well as to overall economic data). If 09 earnings do hit current S&P estimates, then it may be time to revise my personal outlook.