ContraryInvestor - Market Observations

MARKET OBSERVATIONS

HEADS I WIN, TAILS YOU LOSE

MARKET OBSERVATIONS - 6/6

Heads I Win, Tails You Lose...It seems kind of funny that a rip roaring economy is good for stocks (especially tech stocks) and an economic slowdown is also good for stocks (especially tech stocks). Oh well, that's what new era financial manias are all about, right? If the aforementioned premise is true, our humble question is, "just what is bad for stocks?" (Answer: Absolutely nothing. Stocks ALWAYS go up. What's wrong with you?)

Last week's little romp in the indices was quite a display of bravado on the part of investors. Actually, stepping back from the noise and bustle, it's not so hard to understand. What may have been the causes behind a record four day percentage move in the NASDAQ and pretty respectable showings in the SPX and the DOW? Plenty. Here's our laundry list:

The knee-jerk reaction to the potential end of the rate tightening cycle. At this point its simply become Pavlovian. By now it's just a certainty that if interest rates are calm, stocks skyrocket. (And even if interest rates aren't calm, we can anticipate calmness and rally anyway.) Of course we have Greenspan's prior behavior regarding liquidity injections at the drop of a hat to thank for this learned response.

A short squeeze.
Does this really need any explanation? A near 20% one week move in the NAZ (and more in the bull market darlings) usually does the trick in deflating near term expectations for the shorts. We have to believe a good number of dark side bets were put on as so many charts approached and broke 200 day MA's in the last few weeks. It's sickening to have to beat a hasty retreat while short, but often it's just a matter of survival.

Institutions With Cash.
Can you imagine being a mutual fund or other institutional portfolio manager who had actually let cash build up throughout the downturn? Or God forbid you raised cash in the last few weeks? You simply get back on board immediately. No questions asked. You cannot afford to be left behind in performance during an upside runaway. You throw money at the big cap movers.

Individual Investors Who Sold In The Last Few Weeks.
We have been showing you the AMG numbers. A ($7.6) billion outflow two weeks ago. $7.5 billion coming back in last week. It's schizophrenia time. I'm out. That's it. I've lost too much. No, no. I'm back in. This thing is moving. I just want to get back what I lost. For any dejected bulls who may have been foolish enough to sell near the lows, last week was nothing short of a slap in the face. Human greed takes over pronto. Especially for those investors who have not learned that self control and self discipline are the keys to long term investing success.

Last, but certainly not least, the media.
After all, where does American thought and reason come from these days if not the boob tube? (And for sites like Marketwatch, etc. this also includes the computer monitor.) We simply could not believe our ears last Friday when we heard Maria chant from the floor, "Finally the market is getting back to normal". Incomprehensible! This is what mom and pop American investor are listening to and believing. (CNBC has truly become the Jack Welsh infomercial network.) The bullish spin from the talking heads of the Street. The summer rally is here. The bottom is in. It's time to get back in. (Crazily, once again, the Acompora indicator worked like a charm. He literally picked off the bottom of the tech destruction...for now. We're preparing our kitty for the next round of QQQ puts...just as soon as Ralph goes from bearish to bullish.)

Let's Look At The Facts...You already know that countertrend rallies in bear markets can be violent. Bears can lose a claw or two if not careful. Last week's rally was clearly based on the perception that the economy is slowing. Early in the week antics may have been month end window dressing, but Friday's move was all unemployment report driven. Just what about this report.

The unemployment report on Friday signaled widespread weakness. In our mind, it's was just a bit too unbelievable. (Remember we opined a few weeks back that we would not be surprised to see economic reports all of a sudden become favorable to the financial markets the nearer we moved to the election? It's just a comment, not a conspiracy theory.) Within the report, the household measure of employment plunged (991,000), the biggest monthly report decline on record. C'mon now. White hot to stone cold in one month???? Payroll employment ex the census workforce saw its biggest decline since 1991 (a recession). There have been spots in the economy that have pointed to a slowdown, but absolutely nothing like this was indicated. This number was way off the expectations of most all publicly quoted economists. Average hourly earnings in the report were only up .1%. Simply hard to comprehend given the anecdotal evidence we see. The recently published third quarter Employment Outlook Survey from Manpower (the largest staffing services company in the world) reported "unprecedented" demand for workers "across all industries and regions of the country." Hiring plans were the strongest in the 24 year history of the survey. Lastly, just how does a near all time high in consumer confidence jibe with a massive deterioration in employment. To us, it just doesn't. Remember, a presidential election is about perceptions. Pretty strong motivator, isn't it? Especially from one of the most ethical administrations in Washington in generations.

As a follow on to the unemployment report, today's 1Q productivity number of 3.7%, a seven year high, was also a bit outlandish. You and we know that the productivity number is one of the most questionable calculations going. Of course both these numbers should be "comforting" to the Fed. We serious do not mean to sound conspiratorial, but this sudden turn in events for the economy seems a bit too convenient.

The Benefit Of The Doubt...Let's assume the unemployment number is correct and real world employment is simply falling off a cliff. Does a 4.1% unemployment rate really mean the Fed is done? Again, the political nature of the current Fed results in the next move being anyone's guess. Greenspan may balk before the election, but longer term the real inflation and economic numbers will dictate Fed action. As usual, we believe history may be our only guide to tomorrow in conceptual terms. Let's have a look at the unemployment rate over the past 45+ years. Unfortunately we can't overlay the charts, but below it is the like period Fed Funds rate chart. Here we go:

You may have to print the page to see the approximate correlations, but what these two charts say is that every time the Fed has tightened in the last 45 years, the unemployment rate has risen by at least 2% before the Fed was ultimately done. If that is the case this time, we're just getting started. The singular exception is 1994. We would make the strong statement that 1994 was a complete anomaly for a number of reasons. (Fed had lowered rates tremendously prior to the tightening cycle to bail out the banking system. The prior loosening was not about the economy, but rather to save a potential financial calamity. We were embarking on one of the greatest credit expansions in US history. And, the unemployment rate was already in the mid-to-upper 5% range. Almost two full percentage points above where we now stand.) The message we hear loudly and clearly from the relationship in the above charts is that the bulls may be a tad bit premature in their celebratory rally. The real proof lies ahead in the inflation numbers ahead.

All Eyes On The Dollar...All eyes should be on the dollar, but the CNBC crowd was a bit too preoccupied slapping themselves on the back to notice last Friday. The unemployment report and the resulting party in the stock market was met with an immediate drop in the dollar. The bonds also seem to have figured it out in that the initial 2 point pop in bond prices gave way to virtual price flatness by days end. Even gold finally decided it could no longer keep quiet and proceeded to stand up and be counted. Clearly the perceptions of a rising interest rate environment in the US has been a strong prop for the US dollar. If that is being wiped away, King Dollar just may need all the King's horses and all the King's men to save it. (Thank God for forex intervention, right?)

Economic growth has not been the sole province of the US. Foreign country economies (despite props or no props) have been quite strong. If perceptions regarding future strength of the dollar change, we may see a few foreign investors cash in their dollar chips at the window and head to another casino. Preferably an offshore casino. Whether the bulls believe it or not, a falling dollar relative to foreign currencies is anything but bullish. Remember that little approximate $400 billion trade deficit we are running? (Oh yeah, that thing.) This thing:

A strong dollar and weak foreign economies have been two of the major props underlying low inflation in the US over the last few years. Buying cheap foreign goods with expensive US dollars has become the national American pastime, right? Well, now foreign economies are much stronger than they have been in the last few years. They have helped put upward pressure on global commodity prices. If the dollar continues to "leak", we may begin importing inflation as our ravenous appetite for consumer goods continues. Given the still easy availability of credit in the US, do you really expect our trade deficit to significantly reverse itself because the buck is melting down the sides of the sugar cone? To us, a weakening dollar, low inflation, stable interest rates, and continuation of our record trade deficit is not a plausible scenario for coexistence. Just ask any foreign holders of dollar denominated assets.

A month or so ago we opined that we believed OPEC was putting up the price of oil in anticipation of a potential dollar "disruption". (Remember, global crude is priced in dollars.) Well, maybe they were right. One clue will be to see if crude prices shoot higher (with potential production cutbacks) if the dollar falls, as OPEC tries to preserve its profits.

Fairy Tales Can Come True?...Goldilocks is back. That's the new chant. We have the feeling it may be the big bad wolf dressed up as Goldilocks, or possibly Papa Bear in drag. We simply won't know until they try to spook Little Red Riding Bull. Action in the bond market does not tell us that all is well. The charred embers in the gold market may be stirring. The dollar may be planning a vacation "south of the border". The 10 year swap spread, although modestly improved, shouts "my stomach hurts".

Chart Courtesy of Bloomberg

Stocks may be partying for a while, but the credit and currency markets don't seem in the partying mood in the least. They are closer to the panic mode. We just have a hard time agreeing with Maria that "finally the market is getting back to normal". The current experience is about as far from normal as we have ever been.

We're Long Term Investors?...You're probably simply sick of us saying that bear markets are a process. For all the bulls who proclaimed they were long term investors (which is still yet to be tested as we eventually move from denial to fear), there must be at least a few counterpart skeptics who can focus on the same long term. Forget our rantings and ravings. Have a look at these wonderful long term charts from Tim for some true macro perspective. We consider these extremely important perspectives and more than deserving of your attention:

THE DOW

THE S&P

THE NASDAQ

Try to maintain perspective while you await one of the potentially greatest buying opportunities in a generation. It's coming to a location near you.