Tuesday, July 6, 2010

Second Quarter Wrap Up and Random Comments

The quarter has officially ended and I wanted to take a step back and review where we stand and discuss further some significant issues and ideas we've got to address in this investing environment.

As of the end of July 1st 2010 the indices have provided the following returns for the year;
Dow   -5.40%
S&P 500  -6.95%
Nasdaq   -7.82%

This is pretty tough, especially in light of the fact that the indices were actually up more than 10% in April of this year.  Now to be intellectually honest we also need to speak about the gains we've seen.  Remember the scary lows of March 2009?  Since March of 2009 the S&P has rebounded 53% to these current levels.  However we also need to make sure that we take into account that the same index is 34% lower today than it was at the market high in October 2007. 

Since that magical recovery on March 9th of 2009 we have been witness to the invisible hand of government (ok, not so invisible) aiding and assisting the citizens with all its power to create a rebound of asset prices.  We've seen efforts in autos (Cash for Clunkers), housing (Tax Rebates), bank bailouts, green energy programs (weatherizing), Fed open market actions in tandem with Treasury Department intervention to purchase mortgage backed securities, buy troubled assets in the open market, complete US dollar swaps with foreign banks and central governments, and finally outright devaluation of our currency.  We didn't stimulate small business efforts or make sound decisions about the use of government monies, we simply tried to micro manage little areas in the economy rather than making strategic plans that might actually work.  We didn't allow bad firms to accept their fates as failures, no we sloshed easy money around and wasted it in the typical corrupt government way.  All of these efforts have been in the name of "GETTING US BACK TO THE GOOD OLD DAYS", or as I like to recall our then President stated that "we needed to suspend free market capitalism to save free market capitalism!" - (WOW!  I still can't believe he said that!)

As I've noted several times the FED and Treasury gave us their play book, and I've written quite a bit about it in --- PUBLIC ENEMY #1 - DEFLATION .  Their goal is to raise asset prices to get you spending and using credit, essentially "growing" our economy on the backs of those countries that are willing to lend to us. 
These guys don't want us to do this because we need more plasma screens or anything else, it is simply because when the music stops the ponzi scheme falls apart and things end badly.  You must know that this government debt and over leverage is just that, a game of musical chairs that ends really badly when there is only one winner.  Ask Iceland, Greece, and more countries to come how it feels when the game of musical "credit" chairs comes to a screeching halt when the lenders decide to take all the chairs away.

Take a look at this graphic courtesy of Shadow Stats.  This is a graph of our money supply growth.  There are several ways people describe inflation and deflation and one of those is in terms of the growth of the money supply.  As the money supply grows (and its velocity) this is an indication of expansion in the economy.  When a bank obtains a deposit from a person, it must keep 10% of the deposit and then can lend out the rest.  So effectively the money supply or available credit and expand 9 times more and you have exponential growth as borrowers are successful and make their loans productive. 

When money supply growth drops, this is deflationary!  This means that banks are not leading or not receiving their money back.  The money supply in the US is not growing and this is confirming that access to capital is drying up.  So all the efforts of the Fed and Treasury have done nothing.

Source - http://www.shadowstats.com/

Chart of U.S. Money Supply Growth

So we've been bleeding out here obviously since the highs in 2007, but since April of 2010 we've dropped some 20%. Is this just a correction or is this some bigger move?

Let's get this straight, the prescription that will heal the situation IS deflation, yet it is also very painful.  It is clearly the one that is not politically easy and therefore not the own chosen by our government.  Deflation comes with some of the following results;

Strong dollar
High interest rates
No growth
Loss of jobs
Angry citizens
Loss of equity (people investments in assets go to zero)
Angry elites in the political and wealthy classes

Since the deflation scenario is not too good for political incumbents and the leadership, what should we expect?  Well, I fully expect the Son of Stimulus to show up!  The Fed is going to have to step up again and begin buying mortgages and treasuries and we'll have a new round of home purchase and ownership incentives.  The result - don't rush out there and refinance, cause you are going to see a 30 year mortgage at 3% soon enough!

The hope in these actions will be that we'll see an asset inflation in all asset classes (equities, corporate bonds, commodities).  The problem with these moves is that the effectiveness in terms of real bang for the buck is weakening and the effect is not lasting as long each time (just as drug addicts experience).  The other disconnect is that if they actually have success with these programs, we'll seen an INCREASE in treasury yields and this hurts our economy as we need to pay more for the service our debt.  Why do treasury yields increase if they are trying to levitate all the other asset classes?  Simply because investors sell treasuries in the market and buy other assets.  The flood from one area to the next bids up prices in equities, commodities, and corporate bonds and will leave prices lower on treasuries.  This is just the opposite of what has occurred in the last two months --- see the chart of TLT and my post about the signals of BIG THINGS HAPPENING from earlier this week.

Since we have Fed Funds rates at effectively zero and there is no chance of an increase in rates here, the only stimulative options are that the Fed and Treasury are going to need to begin outright purchases of securities (stocks) and or engineer a devaluation of the currency.  These will be effective in the short run, but just like Japan, cannot be carried on forever.  The end result will be just like Japan - slow or non existent growth after many painful years of credit and asset destruction.  Again, this is why the FED will do anything including destroying the purchasing power of your currency to avoid this fate.  The destruction of purchasing power means that assets and objects from outside your country cost significantly more than in the past.  Items like imported goods, oil, gold, and other commodities do really well if they can be effective in pulling the devaluation off.  Now you know the reason for the administration (Geithner and Congress) whining constantly about the revaluation of the Chinese yuan.  We desperately want other currencies to go higher and those Chinese continue to manipulate their currency and refuse to let it rise against our worthless buck!

Can their actions make a sustained impact - or I guess a better question is, can we have this hyper-inflation scenario?  The answer is, NO, not yet.  We cannot have hyper-inflation until we have growth in the economy, and we do not have any growth at all, we have deflation.

I commented earlier this week about the ERCI data showing that we are rolling over and that is just another validation that we are not growing.  Retail sales are falling, consumer confidence is falling, and even today's manufacturing data is showing that it is collapsing.  Just like I posted several times, the "growth" we saw was simply a replacement of inventory draw downs and now we have no one buying new stuff.  Thus I expect second quarter earnings numbers by companies to look and sound good, but when we pay attention to the outlook from company leadership we'll hear a scary story about a retreating consumer, eroding base of orders, and a poor or at least cloudy third quarter.

Well the trend for the last several months has been down now, and that is not a shock  I actually expect some sort of bounce because you typically don't see this type of sustained destruction day in and day out.  The market psychology is turning very pessimistic here where market participants are simply going into treasuries at historically low rates simply because they are fed up with the ups and downs of the market and they want their money back rather than some type of unpromised return.
In the short run what have we discussed almost every time, when everyone believes something, it is probably wrong, so in turn, if everyone is negative we'll probably see some upward movement as we rebound (reload for another drop).  The wave of coming bad news is going to get larger, so you need to be unloading as the market goes higher.  I personally am not adding any longs here because I cannot foresee how long the thrust higher will last before giving way to a lower low.

Let me be clear, you need to take advantage of any move of 3% or 5% to get out of positions that you've been holding.  Be careful and sell your positions as we move higher.  Above this area we have lots of tough slogging for bulls and we'll see how the market can face this now tough resistance.  Key areas on the $SPX to examine are 1037 and also 1055.
If the market falls I'll be watching 1018 and then 993 and 978, after that, it is the low 900s. 

Again, the FED will attempt to do anything and everything to bounce and boost this market.  We might get more shorting bans, we might get more outright purchases of equities by the Fed, we might get dollar devaluations, and we might get a kitchen sink or two...... anything and everything to get something positive going, so don't go shorting the market here, but do get conservative because even a 15% move higher will be met with sellers that feel they have been given a gift from the Lord above and they will be very happy to unload their shares once they get back to their April levels.  (If they get there).

Oh yes, I have so many things I want to write about, but I'll give you a quick teaser topic.  Everyone loves gold, be prepared to witness gold trading down to $1040 or so.  The more you hear about Europe implementing austerity measures means that Gold (the alternative currency) will fall.  People have literally been running to gold because they fear a collapse in the Euro.  In the short run they are not going to profit by chasing gold in their fear.  DO NOT BUY GOLD HERE.  I wouldn't doubt that these buyers are ultimately correct, but you'll be able to buy 10% to 15% cheaper.  I will begin buying more again around this area.

As you can see, there is some support below, but lots of resistance overhead.  Doesn't that April high look far away?


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