Month of May: Sell and Go Away, or Hang in There? (Sonders)

Tuesday, May 15th, 2012

May 14, 2012

by Liz Ann Son­ders, Senior Vice Pres­i­dent, Chief Invest­ment Strate­gist, Charles Schwab & Co., Inc.

Key Points

• We believe the stock market's cor­rec­tion is likely to be less severe this year rel­a­tive to 2010 or 2011.
• Be aware of the pos­si­ble per­ils of fol­low­ing a "sell in May" trad­ing strategy.
• For now, macro concerns—including Europe and the loom­ing "fis­cal cliff"—are trump­ing bet­ter micro news.

The stock mar­ket is in cor­rec­tion mode and investors are on edge. There are likely sev­eral rea­sons for the weak­ness, includ­ing what we pointed out in our early-April report on ele­vated opti­mistic sen­ti­ment. Since sen­ti­ment tends to work a con­trar­ian magic on the mar­ket, we were antic­i­pat­ing a period of con­sol­i­da­tion after the stel­lar six-month, 30% run off the early Octo­ber 2011 low—and we're get­ting it.

Of course, we're also yet again deal­ing with the euro­zone debt cri­sis, but also chop­pier eco­nomic indi­ca­tors in the United States recently, a volatile elec­tion sea­son and con­cerns about the so-called "fis­cal cliff" head­ing into the end of this year. But one of the ques­tions I've got­ten most often recently has been about the sea­sonal phe­nom­e­non called "sell in May and go away," and whether the market's in store for another sum­mer swoon like we've had the past two years.

Macro trump­ing micro

I'll start with "sell in May," but before I do, I want to address an impor­tant gen­eral obser­va­tion. As we've noted many times recently in reports and media appear­ances; and as detailed in a ter­rific recent report by Wall Street research firm Wolfe Tra­han, macro is trump­ing micro. One of the rea­sons for this is the decline in guid­ance investors are receiv­ing from com­pany managements.

In the past, guid­ance was often an anchor of rea­son in volatile times. Events like Euro­pean elec­tions or spik­ing euro­zone sov­er­eign bond yields might not have been such big market-moving events when we could rest on US com­pa­nies' guid­ance as to the future. Add to that rapid-fire trad­ing, short­ened time hori­zons, greatly increased access to infor­ma­tion, greatly increased speed of news' dis­sem­i­na­tion, and much more glob­al­ized eco­nomic and finan­cial sys­tems, and you have a recipe for increased volatil­ity around macro events.

Sell in May?

Much is made every year of the "sell in May" phe­nom­e­non. Its basis is rooted in the fact that the best per­for­mance for the mar­ket has gen­er­ally come in the Novem­ber through April period, while the worst has come between May and October.

There is some truth to the adage. Accord­ing to data com­piled by Ned Davis Research (NDR), through the begin­ning of May this year the aver­age per­for­mance for the period from May 1 through Octo­ber 31 each year since 1950 was 1.2%. The aver­age per­for­mance for the period from Novem­ber 1 through April 30 each year since 1950 was 7.0%.

As com­pelling as those num­bers may seem, there are many things to con­sider, espe­cially if it's your incli­na­tion to develop a trad­ing strat­egy around those sea­sonal pat­terns. First, the cal­en­dar months indi­vid­u­ally tend to fall into either the "hot" or "cold" columns for per­for­mance, as you can see in the table below. Three of the six months that fall into the "all out" period span­ning from May through Octo­ber are actu­ally his­tor­i­cally strong months, while three of the six months that fall into the "all in" period span­ning from Novem­ber through April are actu­ally his­tor­i­cally weak months.

Source: NDR, Inc. (Fur­ther dis­tri­b­u­tion pro­hib­ited with­out prior per­mis­sion. Copy­right 2012 © Ned Davis Research, Inc. All rights reserved.), as of 1928-April 30, 2012.

As you can see, all of the sea­sons seem to be ade­quately rep­re­sented in both columns. And what we know for a fact is that time hori­zons have become much shorter over the recent years, and the reac­tion func­tion gets trig­gered more often. It's likely that many investors may find their patience tested when expe­ri­enc­ing either a great month (or two) dur­ing the May-October "all out" period and/or a poor month (or two) dur­ing the November-April "all in" period. Of course, the sea­sonal trad­ing strat­egy must con­sider trans­ac­tion costs and tax impli­ca­tions.

Sec­tor per­for­mance May-October

For investors who like to take a tac­ti­cal approach to the sea­sonal ten­den­cies, a sec­tor bias strat­egy may be worth con­sid­er­ing. Before I get to the details, let me remind our clients that we moved toward a more sector-neutral strat­egy back in early April when we became more cau­tious about the mar­ket in the short term. Presently the only out­per­form rat­ing we have is on the infor­ma­tion tech­nol­ogy sec­tor, while the only under­per­form rat­ing we have is on the util­i­ties sector.

As you can see in the table below, cour­tesy of The Leuthold Group, cycli­cal groups have tended to out­per­form dur­ing the market's tra­di­tion­ally strong November-April period, while defen­sive sec­tors have been the rel­a­tive win­ners dur­ing the cus­tom­ar­ily weaker May-October period. In fact, the size and per­sis­tence of these effects have been impres­sive (at least since 1989, the span of the analy­sis).

S&P 500 Sec­tor Seasonality

Source: The Leuthold Group, Octo­ber, 1989-April, 2012. Defen­sive sec­tors: con­sumer sta­ples, health care and util­i­ties. Cycli­cal sec­tors: con­sumer dis­cre­tionary, indus­tri­als and mate­ri­als.

Buy in May in elec­tion years?

There's also the rub of this being an elec­tion year, dur­ing which sit­ting out the May through Octo­ber period has his­tor­i­cally not worked well. Using the Dow Jones Indus­trial Aver­age because of its longer his­tory, the mar­ket has been up 4.5% dur­ing elec­tion years in the May-October span ver­sus 2.6% for all years (includ­ing elec­tion years). And for what it's worth, accord­ing to NDR, the mar­ket has bucked sea­sonal weak­ness even more when the incum­bent pres­i­dent has won, with a median gain of 7.6% ver­sus 0.5% when the incum­bent pres­i­dent has lost.

NDR pro­vides a clue as to why this is the case: A cor­rec­tion has occurred dur­ing the sec­ond quar­ter of elec­tion years, on aver­age (sound famil­iar?). But the cor­rec­tion has tended to be con­cen­trated in the sec­ond quar­ter, set­ting the stage for a sum­mer rally.

2012's pos­i­tive off­sets to present weakness

I actu­ally think the sce­nario noted above is more likely than not this year. Mus­cle mem­ory has many investors fret­ting a repeat of 2011 and 2010, when eco­nomic weak­ness in the spring led to bru­tal cor­rec­tions each year, to the tune of –19% and –16%, respec­tively. But there's a long list of pos­i­tive off­sets this year rel­a­tive to the past two years:

• Infla­tion is com­ing down, espe­cially among com­mod­ity prices.
• Credit growth is quite strong, espe­cially for consumers.
• Hous­ing has improved markedly.
• The US man­u­fac­tur­ing sec­tor is humming.
• NFIB's small busi­ness sur­vey made recent upside breakout.
• Job growth is much better.
• Con­sumer con­fi­dence is improving.
• Private-sector lever­age ratios are much improved (debt ser­vic­ing costs are extremely low).
• Recov­ery in state/local gov­ern­ment spending.
• The US econ­omy some­what decou­pling from rest of world; at least Europe.
• US bank capital/health is much bet­ter than Europe's.
• The Euro­pean Cen­tral Bank's Long-Term Refi­nanc­ing Oper­a­tions have reduced like­li­hood of global finan­cial contagion.
• Ger­many appears more will­ing to accept higher infla­tion, open­ing the door to eas­ier mon­e­tary pol­icy for the eurozone.
• Val­u­a­tions are quite cheap, espe­cially on for­ward earnings.
• Investor sen­ti­ment has improved sharply with the cor­rec­tion to-date (mean­ing pes­simism has kicked back in).

I don't think the present cor­rec­tion is over, but do believe it could be kept to within the nor­mal 5–10% range. Since the cur­rent bull mar­ket began in March 2009, the S&P 500 has had 15 cor­rec­tions of more than 5% that were pre­ceded by at least a 5% rally (con­sis­tent with this year's pat­tern). The table below high­lights their dura­tion and ulti­mate per­cent­age drop.

S&P 500 5% Cor­rec­tions

Source: NDR, Inc. (Fur­ther dis­tri­b­u­tion pro­hib­ited with­out prior per­mis­sion. Copy­right 2012 © Ned Davis Research, Inc. All rights reserved.), as of May 11, 2012.

Wall of worry being rebuilt

Tem­per­ing my short-term con­cern has been the afore­men­tioned improve­ment in sen­ti­ment con­di­tions. That said, I think there's likely a bit more pes­simism needed to estab­lish a short-term bot­tom for the mar­ket. As you can see, the well-watched NDR Crowd Sen­ti­ment Poll (CSP) has moved deci­sively lower, but not yet to the extreme pes­simism zone:

Bye-Bye Opti­mism

Source: NDR, Inc. (Fur­ther dis­tri­b­u­tion pro­hib­ited with­out prior per­mis­sion. Copy­right 2012 © Ned Davis Research, Inc. All rights reserved.), as May 8, 2012.

NDR noted in a recent report sev­eral key rea­sons to expect the cor­rec­tion to be within the nor­mal 5–10% range:

• Ini­tial rever­sals in CSP extremes are con­sis­tent with median declines of about 8% within six months.
• The first half of elec­tion years have shown median declines of just less than 10%.
• Once "pre-waterfall" highs have been exceeded, as occurred in Feb­ru­ary of this year, median mar­ket declines have ranged between –3% and –7% within six months.

Sav­ing the worst for last

I think investors and the media may be under­es­ti­mat­ing the impact the com­ing "fis­cal cliff" is hav­ing on mar­ket and busi­ness psy­chol­ogy. The fis­cal cliff refers to the near-simultaneous Jan­u­ary 2013 expi­ra­tion of the Bush tax cuts, the pay­roll tax cuts, emer­gency unem­ploy­ment ben­e­fits and the sequester (auto­matic spend­ing cuts) estab­lished in last summer's debt-limit agreement.

The range of esti­mates for its ulti­mate impact are, unfor­tu­nately, quite wide. The low­est esti­mate I've seen comes from NDR, using Con­gres­sional Bud­get Office assump­tions, with the impact at a rel­a­tively "low" 2.4% of US gross domes­tic prod­uct (GDP). Most esti­mates tend to clus­ter around 3.5% of GDP.

It's impos­si­ble to know what's right because dif­fer­ent assump­tions are being used. But the con­sen­sus is clos­ing in on a worst-case sce­nario of about 4% of GDP. ISI recently put the num­bers into three dis­tinct buck­ets, each with about $200 bil­lion of impact:

1. Pro­vi­sions likely to cre­ate a fis­cal drag (approx­i­mately (≈) $221 bil­lion or 1.4% of GDP):
   • Cuts to dis­cre­tionary spend­ing (≈$84 billion)
   • Tax increases on upper-income Amer­i­cans included in the Afford­able Care Act (≈$21 billion)
   • Pay­roll tax cut (≈$116 billion)
2. Bush tax cuts (≈$200 bil­lion or 1.3% of GDP, although likely impact would be spread over sev­eral years)
3. Items unlikely to be allowed to take affect and thus aren't likely to cre­ate a fis­cal drag (≈$179 bil­lion or 1.1% of GDP):
   • Huge increase in num­ber of Amer­i­cans pay­ing the alter­na­tive min­i­mum tax (≈$94 billion)
   • Sequester cuts (~$85 billion)

There are three addi­tional items that don't fall neatly into ISI's three buck­ets, includ­ing tax exten­ders, extended unem­ploy­ment insur­ance ben­e­fits and the "doc fix," which would together total about $75 bil­lion. These items are not expected to cre­ate a sig­nif­i­cant fis­cal drag.

I actu­ally think this is hav­ing a larger impact on psy­chol­ogy than many believe, espe­cially on the con­fi­dence of cor­po­rate lead­ers and their abil­ity to plan (and guide Wall Street's ana­lysts) for the future.

Mus­cle mem­ory may fail us this year

In sum, there's much to fret about, and volatil­ity is likely to remain ele­vated until this cor­rec­tion has run its course. But a lot has changed in the past two years—much for the better—particularly for domes­ti­cally ori­ented US com­pa­nies. There's at least a lit­tle bit of decou­pling under­way, cer­tainly between the United States and Europe, and that's likely to assist in keep­ing the cor­rec­tion from mir­ror­ing the ones in 2010 and 2011.

Impor­tant Disclosures

The infor­ma­tion pro­vided here is for gen­eral infor­ma­tional pur­poses only and should not be con­sid­ered an indi­vid­u­al­ized rec­om­men­da­tion or per­son­al­ized invest­ment advice. The invest­ment strate­gies men­tioned here may not be suit­able for every­one. Each investor needs to review an invest­ment strat­egy for his or her own par­tic­u­lar sit­u­a­tion before mak­ing any invest­ment decision.All expres­sions of opin­ion are sub­ject to change with­out notice in reac­tion to shift­ing mar­ket con­di­tions. Data con­tained herein from third party providers is obtained from what are con­sid­ered reli­able sources. How­ever, its accu­racy, com­plete­ness or reli­a­bil­ity can­not be guaranteed.Examples pro­vided are for illus­tra­tive pur­poses only and not intended to be reflec­tive of results you can expect to achieve.

Tags: Anchor, Bond Yields, Charles Schwab, Chief Investment Strategist, Debt Crisis, Economic Indicators, Election Season, European Elections, Liz Ann, Media Appearances, Micro News, Perils, Seasonal Phenomenon, Senior Vice President, Sentiment, Stock Market, Swoon, Trading Strategy, Trahan, Volatile Times
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Balance, Grasshopper (Saut)

Tuesday, May 15th, 2012

by Jef­frey Saut, Chief Invest­ment Strate­gist, Ray­mond James

May 15, 2012

I received so many requests to put last Tuesday’s ver­bal strat­egy com­ments into writ­ten form, and that’s exactly what I have done this morn­ing. To wit, I was always entranced with the 1970’s TV show “Kung Fu” star­ring David Car­ra­dine as Kwai Chang Caine. The show cen­tered on an orphaned Amer­i­can boy (Kwai Chang) that is admit­ted as a stu­dent to the Shaolin tem­ple in China. There his men­tor, Mas­ter Po, teaches him the ways of the Shaolin priests. In addi­tion to learn­ing the mar­tial arts Kwai Chang, affec­tion­ately named “grasshop­per,” is also instructed in the ways of life. In one such les­son Mas­ter Po says, “Bal­ance, grasshop­per, bal­ance” – imply­ing that every­thing in life needs to be “in bal­ance.” Sim­i­larly, investors’ port­fo­lios need to be “in bal­ance,” or more appro­pri­ately rebal­anced periodically.

Port­fo­lio rebal­anc­ing, when done cor­rectly, is an art form. Sim­ply stated, port­fo­lio rebal­anc­ing is the strate­gic redis­tri­b­u­tion of asset classes within a port­fo­lio to keep said portfolio’s objec­tives in line with its orig­i­nal objec­tive. As John Valen­tine, of Valen­tine Cap­i­tal, notes:

To pro­vide a sim­pli­fied alle­gory, think of invest­ment plan­ning for the future as an auto­mo­bile, con­vey­ing an investor to his or her finan­cial goals. The invest­ment port­fo­lio is its motor, the asset allo­ca­tion model is the fuel mix­ture and the assets invested are the fuel. The more effi­ciently the motor runs, the greater the speed with which the whole vehi­cle trav­els toward the des­ti­na­tion. Should the fuel mix­ture, or asset allo­ca­tion run too rich, the motor wastes pre­cious fuel. Should it run too thin, the car has trou­ble achiev­ing enough for­ward momen­tum. ... Many indi­vid­u­als on the road to their finan­cial goals fail to make these peri­odic adjust­ments and still even­tu­ally arrive. Not sur­pris­ingly, the investor who rebal­ances his port­fo­lio at reg­u­lar inter­vals may arrive sooner and with more fuel in his tank. ... Rebal­anc­ing a port­fo­lio is cru­cial to the investor seek­ing to reduce the volatil­ity in a port­fo­lio and increase cash flow simul­ta­ne­ously. ... The longer a port­fo­lio is left unbal­anced, the more com­pro­mised its asset allo­ca­tion may become. There are two poten­tially neg­a­tive reper­cus­sions asso­ci­ated with a com­pro­mised allo­ca­tion. Being over­ex­posed to the down­side and under­ex­posed to the upside. Don’t let this hap­pen to you!

Regret­tably, most indi­vid­ual investors don’t have the dis­ci­pline, or the skill sets, to actively rebal­ance their port­fo­lios. That’s why indi­vid­u­als are best advised to seek pro­fes­sional assis­tance in rebal­anc­ing their port­fo­lios, or for that mat­ter seek a pro­fes­sional advi­sor to help them with all of their invest­ment needs. Man­i­festly, cor­rect asset allo­ca­tion can increase invest­ment returns and lower risk when “bets” are scaled to the advisor’s skill level. Most good invest­ment pro­fes­sion­als have suc­cess­ful “hit rates” of around 60%. That means they make a lot of mis­takes and there­fore should make smaller allo­ca­tion bets. His­tory sug­gests that large bets will even­tu­ally cause large losses and the end of an asset allo­ca­tion pro­gram. Nev­er­the­less, most clients and many advi­sors want to make big­ger bets than their prov­able skills justify.

Clearly, asset allo­ca­tion plays a key role in the invest­ment process; how­ever, I have some other thoughts I think you should con­sider. For exam­ple, a lot of what passes for bril­liance, or incom­pe­tence, in invest­ing is the ebb and flow of invest­ment style (growth, value, for­eign, small cap, etc.) and/or sec­tor per­for­mance. Since oppor­tu­ni­ties by style and sec­tors tend to regress, past per­for­mance is often neg­a­tively cor­re­lated with future rel­a­tive per­for­mance. Still, many investors feel com­pelled to go with past per­for­mance and there­fore rotate into pre­vi­ously strong styles, and strong sec­tors, which then regress leav­ing them with losses. A good advi­sor can mit­i­gate this ten­dency, but a good advi­sor is harder to pick than a good stock.

To this point, good advi­sors often inter­nal­ize deci­sions while ama­teurs learn all the rules and pro­ce­dures. It fol­lows that ama­teurs can often pre­cisely explain what they are doing and why they are doing it. An expert, how­ever, often just knows when they are right. Since investors typ­i­cally want to hear a log­i­cal and clear-cut invest­ment process, many tend to end up with an elo­quent ama­teur rather than a sometimes-incomprehensible expert. Ladies and gen­tle­men, never under­es­ti­mate the effec­tive­ness of an eccen­tric or unusual advi­sor since “knack” tends to win out over learned skill in the invest­ment arena. Most impor­tant is get­ting the big pic­ture right and the best long-term pre­dic­tor of future “big pic­ture” equity returns is the cur­rent value of the mar­ket – things like, price/earnings, price/dividends, price/sales, price/replacement cost (Tobin’s Q ratio), etc. Cur­rently, all of these mea­sure­ments indi­cate the equity mar­kets are rea­son­ably priced.

To this rebal­anc­ing port­fo­lios point, I rec­om­mended doing so after the “buy­ing stam­pede” ended in late Jan­u­ary. My sug­ges­tion was to raise some cash before the envi­sioned 5–8% cor­rec­tion. At last Wednesday’s intra­day low the S&P 500 (SPX/1353.39) was off 5.5% from its April 2 high, and in my ver­bal strat­egy com­ments I rec­om­mended start­ing to put some of that cash back to work in equi­ties. While the “set up” wasn’t per­fect, because we never got that porno­graphic plunge type of hour into the 1320–1340 sup­port zone, at Wednesday’s low of ~1343 the SPX was close enough for gov­ern­ment work. More­over, the NYSE McClel­lan Oscil­la­tor was prob­ing over­sold ter­ri­tory (see chart on page 3) and there was a huge down­side non-confirmation. Ver­ily, last week the SPX broke below its April 10 reac­tion low of 1357.38, yet all of the other indices I mon­i­tor did not vio­late their respec­tive recent reac­tion lows (read: down­side non-confirmation). Then there is the con­tin­u­ing diver­gence between the McClel­lan Oscil­la­tor and the pric­ing action of the SPX, which often occurs at an intermediate-term bot­tom. And, then there was this from my friend Jim Kennedy, cap­tain of the astute Atlanta-based hedge fund con­sult­ing firm of Diver­gence Analy­sis, whose pro­pri­etary stock mar­ket ana­lyz­ing soft­ware I use and embrace:

After we sent out our email prices con­tin­ued to slide last Fri­day. At the close, our S&P 500 and NYSE mod­els closed the day with some diver­gence bot­tom­ing sig­nals. Mon­day should be the test as to whether prices hold here and rally, or fail (see his charts on page 3).

Plainly, I agree with Jim’s com­ments for as stated, “While the ‘set up’ wasn’t per­fect, it was close enough for gov­ern­ment work.” I too think the first part of this week is crit­i­cal because the SPX has tested over­head resis­tance at 1366 twice and has not had any suc­cess in trav­el­ing above that level. This lack of rebound energy sug­gests the SPX could drop into the often men­tioned 1320–1340 sup­port zone, which should mark the bot­tom for this cor­rec­tion and pro­vide another good entry point for long stock posi­tions. Last week, how­ever, the only major index that was pos­i­tive was the D-J Util­ity Index ($UTIL/472.01). Mean­while, of the 10 macro sec­tors only Health­care, Util­i­ties, and Telecom­mu­ni­ca­tion were up on the week. The strength in Telecom­mu­ni­ca­tion was likely dri­ven by the upside chart break­outs in AT&T (T/$33.59/Market Per­form), Ver­i­zon (VZ/$41.16/Market Per­form), and Cen­tu­rylink (CTL/$39.52/Strong Buy). Speak­ing to indus­try groups, of the 63 groups I mon­i­tor the ones cur­rently on “buy sig­nals” for the short/intermediate term are: REITs, Insur­ance P/C, Banks, Restau­rants, Build­ing Mate­ri­als, Spe­cialty Chem­i­cals, Food, Health­care Supply/Equipment, and Phar­ma­ceu­ti­cals. Some names from Ray­mond James’ research uni­verse that screened pos­i­tively on both their fun­da­men­tal and tech­ni­cal met­rics accord­ing to my work, and are favor­ably rated by our fun­da­men­tal ana­lysts, include: All­state (ALL/$34.83/Strong Buy), Simon Prop­erty (SPG/$156.08/Outperform), Abbott Labs (ABT/$62.04/Outperform), Cerner (CERN/$79.92/Outperform), Intu­itive Sur­gi­cal (ISRG/$558.95/Outperform), Hunt­ing­ton Banc­shares (HBAN/$6.54/Strong Buy), and Kimco Realty (KIM/$19.61/Outperform).

The call for this week: The stock mar­ket has been con­sol­i­dat­ing its huge gains from the Octo­ber 4 under­cut low for roughly three months in a ~75 point range (1350–1420). That con­sol­i­da­tion has allowed the market’s inter­nal energy to be rebuilt and the over­sold con­di­tion to be worked off. Because of that process, I con­tinue to think the odds that we will see a move below the 1320–1340 zone remain pretty dim. Accord­ingly, I sus­pect the stock mar­ket is going to put in an inter­me­di­ate bot­tom prob­a­bly this week.

Tags: Allegory, Art Form, Asset Allocation Model, Asset Classes, Chief Investment Strategist, David Carradine, Financial Goals, Fuel Mixture, Grasshopper, Investment Planning, Investment Portfolio, jeffrey saut, John Valentine, Last Tuesday, Periodic Adjustments, Portfolio Rebalancing, Precious Fuel, Raymond James, S Tv, Shaolin Temple In China
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Panic Is Not a Strategy—Nor Is Greed (Sonders)

Monday, May 14th, 2012

Panic Is Not a Strategy—Nor Is Greed

Updated May 10, 2012
by Liz Ann Son­ders, Senior Vice Pres­i­dent, Chief Invest­ment Strate­gist, Charles Schwab & Co., Inc.

Key Points

• Orig­i­nally pub­lish­ing in 2008, it's time for a refresher about the per­ils of panic.
• Asset allo­ca­tion, diver­si­fi­ca­tion and rebal­anc­ing are as close to a "free lunch" as you can get as an investor.
• In a world where time hori­zons have shrunk pre­cip­i­tously, think longer-term.

If mar­kets are good at one thing, it's remind­ing investors that they don't go up unin­ter­rupted for­ever. We wit­nessed sev­eral bruis­ing cor­rec­tions in 2011 before the market's strong rally between Octo­ber 2011 and April 2012. As the chart "Fear Spikes Again" below illus­trates, the CBOE Volatil­ity Index® has picked up again, but remains below the unpar­al­leled heights of the 2008 credit cri­sis and the more-recent ele­va­tion in 2011.

Fear Up, But Well Down From Highs

Source: Fact­Set, as of April 20, 2012. The CBOE Volatil­ity Index ("VIX") is a reg­is­tered trade­mark of the Chicago Board Options Exchange. The VIX Index shows the market's expec­ta­tion of 30-day volatil­ity. For more infor­ma­tion on the VIX, visit www.cboe.com/micro/vix/

We're always quick to remind investors that nei­ther panic nor greed is an invest­ment strat­egy, and that the best foun­da­tion to help pro­tect a port­fo­lio against the unpre­dictable is having—and stick­ing with—a long-term strate­gic asset allo­ca­tion plan.

Mind­set mat­ters: strate­gic trumps tactical

In real­ity, investors should rarely, if ever, react to a dra­matic short-term move in the mar­ket. As intrigu­ing as it may seem to try to catch bot­toms and get out at tops in order to reap big prof­its (or so you think), the "tac­ti­cal" (or shorter-term) approach to invest­ing has its lim­i­ta­tions ... and its risks.

We believe it's the "strate­gic" asset allo­ca­tion decision—and the abil­ity to stick with it through the dis­ci­pline of rebalancing—that will ulti­mately reap the great­est rewards. These deci­sions are not a func­tion of short-term mar­ket gyra­tions or fore­casts (mine, yours or any­one else's), but are tied to your risk tol­er­ance and long-term goals. Devel­op­ing and main­tain­ing the right long-term asset mix is by far the most impor­tant set of deci­sions a client will ever make.

Never before has infor­ma­tion about the global econ­omy and mar­kets been more read­ily avail­able and dis­sem­i­nated. As a result, global mar­kets have become very inter­con­nected. In turn, our reac­tion mech­a­nisms have kicked in, and investor time hori­zons have short­ened dramatically—but not nec­es­sar­ily to our advan­tage. Yes, the long term is really just a series of short-term events, but it's how we react to them that decides our ulti­mate fate as investors.

Asset allo­ca­tion and diver­si­fi­ca­tion: investors' "free lunch"

One of the most impor­tant areas where Schwab offers advice is the devel­op­ment of a long-term strate­gic asset allo­ca­tion plan. Many investors assume that their posi­tion along the risk spec­trum from con­ser­v­a­tive to aggres­sive is largely based on their age and time hori­zon. But a more impor­tant fac­tor is their risk tol­er­ance. Also impor­tant is judg­ing the dif­fer­ence between an investor's finan­cial risk tol­er­ance (their abil­ity to finan­cially with­stand volatile mar­kets) and their emo­tional risk tolerance—a spread that's often quite wide and only acknowl­edged dur­ing tumul­tuous mar­ket environments.

I've known plenty of older investors who thrive on the risk asso­ci­ated with an aggres­sive invest­ment stance. I've also known plenty of young investors who can't stom­ach any losses. Too often, investors use a rearview mir­ror to make their invest­ing deci­sions, by look­ing at past per­for­mance as a guide to future results. A mir­ror is a valu­able tool but only when turned on your­self to judge your own circumstances—tolerance for risk, time hori­zon, income needs, etc. As I've often said, there are very few free lunches in invest­ing. Asset allo­ca­tion, diver­si­fi­ca­tion and peri­odic rebal­anc­ing are as close as you get.

Risk tol­er­ance: Know what you can stomach

In the chart "Schwab's Strate­gic Asset Allo­ca­tion Mod­els" below, you'll see our long-term rec­om­men­da­tions regard­ing dif­fer­ent asset classes for three types of investors: con­ser­v­a­tive, mod­er­ate and aggres­sive.¹ Note the vast dif­fer­ences in allo­ca­tions to riskier asset classes, includ­ing inter­na­tional equity, as you move up the risk spectrum.

Clearly, over the long term, given the bet­ter per­for­mance by the riskier asset classes, a more aggres­sive allo­ca­tion has his­tor­i­cally reaped higher rewards in terms of returns. But there is a dark side to an aggres­sive posture's higher returns—the risk taken in get­ting there.

Tags: Allocation Plan, Cboe Volatility Index, Charles Schwab, Chicago Board Options, Chicago Board Options Exchange, Chief Investment Strategist, Credit Crisis, Diversification, Free Lunch, Greed, Investment Strategy, Liz Ann, Perils, Rewa, Senior Vice President, Strategic Asset Allocation, Term Approach, Time Horizons, Unparalleled Heights, Vix Index, Volatility Index Vix
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Here We Go Again....or Not? (Sonders)

Sunday, May 13th, 2012

Here We Go Again....or Not?

May 11, 2012

by Liz Ann Son­ders
Senior Vice Pres­i­dent, Chief Invest­ment Strate­gist, Charles Schwab & Co., Inc.,
Brad Sorensen
CFA, Direc­tor of Mar­ket and Sec­tor Analy­sis, Schwab Cen­ter for Finan­cial Research, and,
Michelle Gib­ley
CFA, Direc­tor of Inter­na­tional Research, Schwab Cen­ter for Finan­cial Research

Key Points

• Softer eco­nomic data has prompted con­cerns that the mar­ket may be headed for a sum­mer swoon—similar to the pre­vi­ous two years. We believe the back­drop is decid­edly dif­fer­ent (and bet­ter) this time around but investor and busi­ness con­fi­dence will con­tinue to be important.
• Some appear to be hop­ing for weaker data in order to spur the Fed to enact another round of quan­ti­ta­tive eas­ing (QE3). We believe the bar is much higher and that the Fed should look to return to a more nor­mal mon­e­tary stance. Com­pli­cat­ing the over­all pic­ture and the Fed’s job is the com­ing "fis­cal cliff" out of Wash­ing­ton at the end of this year.
• The polit­i­cal sit­u­a­tion in Europe has injected even more uncer­tainty into an already ten­u­ous envi­ron­ment. Pub­lic cries for a reduc­tion in aus­ter­ity, despite many pro­posed mea­sures not tak­ing affect yet, raises ques­tions as to the sus­tain­abil­ity of the euro­zone as is. Spend­ing cuts are impor­tant, but must be accom­pa­nied by seri­ous struc­tural changes that encour­age growth and inno­va­tion to pro­vide hope for the future.

NOTE: The next Schwab Mar­ket Per­spec­tive will be pub­lished one week later than normal—June 1, 2012.

We've seen this movie before … or have we? After start­ing out the pre­vi­ous two years in a pos­i­tive direc­tion, stocks expe­ri­enced dis­ap­point­ing down­turns begin­ning around this time of each year and con­tin­u­ing through­out the sub­se­quent sum­mers. Recently we've seen eco­nomic data soften, global con­cerns rise, Trea­sury yields fall, and stocks cor­rect, prompt­ing more ques­tions as to whether we're see­ing a very unwel­come sequel. We believe not.

Before get­ting into why we don't believe we're in store for Sum­mer Swoon III (a sequel, like many, that no one wants to see), we want to again point out that try­ing to time the mar­ket is largely a los­ing game for investors. And we also con­tinue to remind investors that stick­ing to a dis­ci­plined long-term plan is key, rather that chas­ing crowd psy­chol­ogy or past returns. We're reminded of the con­tin­ued chas­ing men­tal­ity that almost inevitably leads to dis­ap­point­ment as ISI Research reported that bond mutual fund inflows were at a record high dur­ing the first four months of the year, while equity fund out­flows were the third largest on record.

Cur­rently, investor appre­hen­sion is ris­ing, indi­cated by increas­ing volatil­ity and a stock mar­ket in cor­rec­tion mode, as the pos­si­bil­ity of a replay of the pre­vi­ous two years is con­sid­ered. How­ever, we believe there are sev­eral impor­tant fun­da­men­tal dif­fer­ences that help to sup­port a renewed mar­ket advance before too long. First, we aren't deal­ing with any major nat­ural crises such as the Japan­ese earth­quake and tsunami we saw last year; or the spike in food infla­tion that unleashed the "Arab Spring." In fact, com­mod­ity prices are largely mov­ing lower, allow­ing cen­tral banks around the world to ease mon­e­tary pol­icy, as we’ve seen in Brazil, Aus­tralia, and India among oth­ers. And while there are still major con­cerns regard­ing the debt cri­sis in Europe, dis­cussed in fur­ther detail below, the Euro­pean Cen­tral Bank (ECB) has made moves that indi­cate they will be aggres­sive to pre­serve some sem­blance of sta­bil­ity in the Euro­pean mar­kets. Finally, in the United States we're see­ing fur­ther signs of hous­ing sta­bi­liza­tion, a con­tin­ued improv­ing job sit­u­a­tion, and a rebound in auto sales, which is now a larger dri­ver of GDP than res­i­den­tial investment.

But there's the impact of "mus­cle mem­ory" given the past two years' volatil­ity; and per­cep­tion can become real­ity. There is a risk that investors increas­ingly lose con­fi­dence in the eco­nomic recov­ery, pres­sur­ing stocks, and caus­ing busi­nesses to again pare back. In the short term, mar­ket per­for­mance can have more to do with sen­ti­ment than fun­da­men­tals, again illus­trat­ing the folly of short-term timing.

Tem­po­rary Soft­ness or a New Trend?

Data has been mixed lately, with regional man­u­fac­tur­ing sur­veys largely dis­ap­point­ing: the Chicago PMI fell to its low­est level since Novem­ber 2009, although remain­ing in expan­sion­ary ter­ri­tory and the Dal­las Fed Index slipped into neg­a­tive ter­ri­tory. The national index pro­vided more encour­age­ment as the ISM Man­u­fac­tur­ing Index rose to 54.8, the best level since June 2011, while the for­ward look­ing new orders com­po­nent rose to 58.2, the best level since April 2011. This is dis­tinctly bet­ter than the trend in most global PMIs. How­ever, more con­cern came in the form of the ISM Non-Manufacturing Index, which soft­ened to 53.5 from 56. But while the impor­tant ser­vice sec­tor showed some soft­ness, we con­tinue to see con­sumers improve their bal­ance sheets, which should help to sup­port spend­ing going forward.

Con­sumers' debt posi­tion is much improved

Source: Fact­Set, Fed­eral Reserve. As of May 7, 2012. Includes mort­gage and con­sumer debt, auto lease pay­ments, rental pay­ments, home­own­ers insur­ance, and prop­erty tax payments.

Key to con­sumer spend­ing con­tin­u­ing to hold up is likely the con­tin­ued improve­ment in the job mar­ket, which has been in ques­tion lately. Job­less claims started to creep higher before expe­ri­enc­ing a rel­a­tively sharp rever­sal recently and remain­ing well below the crit­i­cal 400,000 level. How­ever, pay­roll growth con­tin­ued to be dis­ap­point­ing as a soft read­ing for March was fol­lowed with another one in April. We saw ADP report a mere 119,000 pri­vate jobs were added, while the Bureau of Labor Sta­tis­tics (BLS) reported that non­farm pay­rolls expanded by a weak 115,000 posi­tions; although the pre­vi­ous two months were revised higher. The unem­ploy­ment rate fell to 8.1% due largely to a drop in the labor par­tic­i­pa­tion rate, which now stands at 63.6%—the low­est level since 1981.

Tags: Austerity, Backdrop, Business Confidence, Charles Schwab, Chief Investment Strategist, Economic Data, Eurozone, Global Concerns, Liz Ann, Market Perspective, Monetary Stance, Political Situation, Positive Direction, Research Key, Sector Analysis, Senior Vice President, Sequel, Sustainability, Swoon, Treasury Yields
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Jeffrey Saut: Investment Outlook (May 7, 2012)

Monday, May 7th, 2012

by Jef­frey Saut, Chief Invest­ment Strate­gist, Ray­mond James
May 7, 2012

“Toto, I have a feel­ing we’re not in Kansas any­more.”
... Dorothy; The Wiz­ard of Oz

While most peo­ple know “The Wiz­ard of Oz” as one of the most pop­u­lar films ever made, what is lit­tle known is that the book was based on an eco­nomic and polit­i­cal com­men­tary sur­round­ing the debate over “sound money” that occurred in the late 1800s. Indeed, L. Frank Baum’s book was penned in 1900 fol­low­ing unrest in the agri­cul­ture arena due to the debate between gold, sil­ver, and the dol­lar stan­dard. The book, there­fore, is sup­pos­edly an alle­gory of these his­tor­i­cal events, mak­ing the events eas­ier to under­stand. In said book, Dorothy rep­re­sents tra­di­tional Amer­i­can val­ues. The Scare­crow por­trays the Amer­i­can farmer, the Tin Man rep­re­sents the work­ers, and the Cow­ardly Lion depicts William Jen­nings Bryan. Recall that at the time Mr. Bryan was the offi­cial stan­dard bearer for the “sil­ver move­ment,” as well as the unsuc­cess­ful Demo­c­ra­tic pres­i­den­tial can­di­date of 1896. Inter­est­ingly, in the orig­i­nal story Dorothy’s slip­pers were made of sil­ver, not ruby, imply­ing that sil­ver was the Pop­ulists’ solu­tion to the nation’s eco­nomic woes. Mean­while, the Yel­low Brick Road was the gold stan­dard, and Toto (Dorothy’s faith­ful dog) rep­re­sented the Pro­hi­bi­tion­ists, who were an impor­tant part of the sil­verite coali­tion. The Wicked Witch of the West sym­bol­izes Pres­i­dent William McKin­ley; and the Wiz­ard is Mark Hanna, who was the chair­man of the Repub­li­can Party and made promises that he could not keep. Obvi­ously, “Oz” is the abbre­vi­a­tion for “ounce.”

It should be noted that before 1873 the U.S. dol­lar was defined as con­sist­ing of either 22.5 grains of gold or 371 grains of sil­ver. This set the legal price of sil­ver in terms of gold at a ratio of roughly 16:1 and put the coun­try on a gold/silver bimetal­lic stan­dard. Since both met­als had other uses than just coinage, when­ever the ratio got out of whack ratio­nal peo­ple would buy the cheaper metal and take it to the mint for coinage. That pro­vided a nat­ural sta­bi­liz­ing arbi­trage. With the 1873 Coinage Act, how­ever, the sil­ver dol­lar was omit­ted, effec­tively shift­ing the coun­try from a bimetal­lic to purely a gold stan­dard. Other coun­tries soon fol­lowed, and as tons of sil­ver was unloaded, the mar­ket price of sil­ver to gold rose from 16:1 to a ratio of 40:1. The result was that the dol­lar was now linked to a metal that was get­ting scarcer. Par­tic­u­larly hurt by these events were the net debtors, among them the farm­ers because they had to face a ris­ing real value of their dollar/gold denom­i­nated debts com­bined with declin­ing agri­cul­tural prices. Now, while there was a bunch of “noise” in between (The Sher­man Sil­ver Pur­chase Act of 1890, the panic and depres­sion of 1893, etc.), the sit­u­a­tion hit its zenith in 1896 cul­mi­nat­ing with William Jen­nings Bryan’s “Cross of Gold” speech at the Demo­c­ra­tic National Convention.

Plainly, the tur­moil fol­low­ing the “1873 Coinage Act,” the “Sher­man Sil­ver Pur­chase Act of 1890,” and the sub­se­quent panic, and depres­sion, of 1893 left the phrase “time for a change” swirling across the coun­try as cit­i­zens strug­gled to cor­rect the numer­ous wrong-footed schemes that were so hastily con­ceived by the country’s elected lead­ers. While I have digressed, I find mon­e­tary his­tory truly fas­ci­nat­ing and would note that the value of our cur­rent dol­lar, mea­sured in 1900 dol­lars, is worth roughly $0.03. And that, ladies and gen­tle­men, is why you want to have your dol­lars in pro­duc­tive assets that have healthy cash flows, hope­fully pay div­i­dends, and will keep up with the infla­tion that is most cer­tainly com­ing our way.

I revisit the dollar/gold topic this morn­ing because I think the most impor­tant chart in the world may be in the process of break­ing down. The chart in ques­tion is that of the U.S. Dol­lar. Since Jan­u­ary of this year the Dol­lar Index ($DXY/79.59) has reversed its pat­tern of mak­ing higher highs and higher lows, as can be seen in the chart on page 3. Inter­est­ingly, the last short-term dol­lar “top out” occurred on last month’s bad employ­ment report, so given Friday’s poor employ­ment report the dollar’s path this week should be watched closely. More­over, despite the offi­cial line from the pow­ers that be, I think Ben Bernanke actu­ally wants a lower dol­lar. Not only would it bring about the whiff of infla­tion that is needed, it also would increase our exports and allow us to pay back our debts with cheaper dol­lars. A break­down below February’s intra­day reac­tion low of 78.12, which would also break the index below its 200-day mov­ing aver­age (DMA) at 78.36, would likely con­firm the dollar’s down­side. The quid pro quo is I think a weaker dol­lar would be bull­ish for the equity markets.

Speak­ing to gold, I have been bull­ish on gold, and stuff stocks in gen­eral (energy, cement, tim­ber, agri­cul­ture, water, elec­tric­ity, pre­cious met­als, etc.), ever since China joined the World Trade Orga­ni­za­tion (WTO) in 2001 on the assump­tion that when per capita incomes rise peo­ple con­sume more “stuff.” We rode that theme to large prof­its until the Dow The­ory “sell sig­nal” of Novem­ber 2007 where said invest­ments had grown into such large “bets” that we rec­om­mended sell­ing 30% — 40% of our stuff stocks to rebal­ance port­fo­lios. The strat­egy was to allow long-term cap­i­tal gains to accrue to port­fo­lios, and raise some cash, going into what we thought was going to be a dif­fi­cult 2008. Since the stock market’s bot­tom­ing process began in Octo­ber 2008 (actu­ally on 10/10/08 when 92.6% of all stocks traded made new annual lows, a sta­tis­tic I have not seen in more than 40 years in this busi­ness) gold has been on a tear, hav­ing ral­lied from $681 into last summer’s clos­ing reac­tion high of $1891.90. At that time I warned investors I was putting “in” gold’s short/intermediate high, and rec­om­mended adjust­ing pre­cious met­als posi­tions accord­ingly, when I bought six of our son’s gold coins to help fund his sum­mer excur­sion to Europe. The result was I paid slightly over $1900 per coin; and, so far that has proven to be the peak price. While I think gold is in a con­sol­i­da­tion pat­tern that will even­tu­ally be resolved with higher prices, I don’t think that will hap­pen for a while.

Turn­ing to the stock mar­ket, the S&P 500 (SPX/1369.10) and the NASDAQ Com­pos­ite (COMP/2956.34) suf­fered their worst week of the year, falling 2.44% and 3.68%, respec­tively. The weekly wilt left both indices near their lows for the week, as well as below their 50-DMAs. Such action brings into view the intra­day April reac­tion lows of 1357.38 for the SPX and 2946.04 for the COMP. A con­firmed close below those lev­els would rep­re­sent a break below what a tech­ni­cal ana­lyst would term a “spread triple bot­tom” with short-term neg­a­tive impli­ca­tions. That caused one old Wall Street wag to exclaim, “Triple bot­toms rarely hold!” This week should hold the key for that state­ment. Last week’s con­ster­na­tions cen­tered around eco­nomic and earn­ings reports. As we have been warn­ing since the begin­ning of April, the eco­nomic reports have taken a decided turn towards the softer side. Last week that skein wors­ened since of the 21 reports released only seven came in bet­ter than expected. Like­wise, the 1Q12 earn­ing report “beat rate” has been soft­en­ing over the past three weeks, hav­ing fallen from a 73% read­ing to last week’s 61% level for the S&P 1500. Even worse is the decline in com­pa­nies giv­ing pos­i­tive for­ward earn­ings guid­ance. Of course, that is caus­ing ana­lysts to reduce their expec­ta­tions. Accord­ingly, of the 10 S&P macro sec­tors the best upward earn­ings revi­sion ratios are in Con­sumer Dis­cre­tionary (+19.1%), Finan­cials (+18.6%), and Indus­trial (+17.7%). Mean­while, Energy has the worst ratio (-36.3%), likely dri­ven by falling energy prices and bulging inventories.

The call for this week: If the spread triple bot­tom around SPX 1358 holds this week there should be another rally attempt, albeit still within the range-bound envi­ron­ment we have seen for the past eight weeks. If the 1358 level fails to hold, then we might just get what I have been look­ing since the begin­ning of Feb­ru­ary, a quick dip into the 1320 – 1340 sup­port zone. If that occurs, it would most cer­tainly leave the NYSE McClel­lan Oscil­la­tor very over­sold, as well as finally raise my daily and weekly stock mar­ket inter­nal energy indi­ca­tors back to lev­els that would reg­is­ter a full load of energy, some­thing I have been wait­ing for the past eight weeks. And this morn­ing, given the “throw the bums out” elec­tion results in the EU, it looks like the SPX’s 1358 is at least going to be tested if not vio­lated. Per­son­ally, I would like to see a plunge into the 1320 – 1340 zone, but they don’t run Wall Street for my ben­e­fit. As for vehi­cles under con­sid­er­a­tion for your “buy list,” in addi­tion to the index exchange-traded prod­uct of your choice, in last week’s ver­bal strat­egy com­ment we listed three com­pa­nies that are favor­ably rated by our fun­da­men­tal ana­lysts and are “triple plays.” Triple plays are com­pa­nies that have beaten earnings/revenue esti­mates and have raised for­ward earn­ings guid­ance. Those names were: Abbott Labs (ABT/$62.41/Outperform); Equinix (EQIX/$158.94/Strong Buy); and Intu­itive Sur­gi­cal (ISRG/$565.16/Outperform).

Click here to enlarge

Tags: American Farmer, Chief Investment Strategist, Cowardly Lion, Democratic Presidential Candidate, Dollar Standard, Economic Woes, Investment Outlook, jeffrey saut, L Frank Baum, Mark Hanna, President William Mckinley, Price Of Silver, Prohibitionists, Tin Man, Traditional American Values, Wicked Witch Of The West, William Jennings Bryan, William Mckinley, Wizard Of Oz, Yellow Brick Road
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Late Bull Stampede Turns Bears Into April Fools (Coté)

Monday, May 7th, 2012

by Dou­glas Coté, Chief Invest­ment Strate­gist, ING Invest­ment Management

The bears grew hope­ful early in the month, as global mar­kets were spooked by goings-on in the euro zone: Spain briefly brought back fears of bailout Armaged­don, the Dutch gov­ern­ment col­lapsed, and PMI num­bers for the region came in weaker than expected. April Fools! The bull mar­ket remains intact and offers com­pelling value for those look­ing to build wealth.

At its April trough, the S&P 500 was down 3.5% for the month. How­ever, the bull awoke mid-April, prod­ded by relent­less cor­po­rate strength that con­tin­ues to con­found Wall Street. Block­buster cor­po­rate prof­its were led by finan­cials, fol­lowed by indus­tri­als and put over the top by tech­nol­ogy. With a mea­ger 0.89% con­sen­sus expec­ta­tion for first quar­ter earn­ings growth, Wall Street got it wrong; in fact, con­sid­er­ing that first quar­ter earn­ings growth, at press time, stands at an explo­sive 8.8%, “got it wrong” is a seri­ous under­state­ment. The S&P 500 surged into the end of the month, mak­ing up nearly all its lost ground.

This per­for­mance is no joke for those who are miss­ing out on an extra­or­di­nary bull mar­ket that has just entered its fourth year. It is not too late for savers to turn into investors, but this market’s per­sis­tent and deter­mined march for­ward will not wait for the hes­i­tant. Investors must resist the all-ornothing approach to risk; a mod­er­ate risk pos­ture has been hand­somely rewarded over the past three years despite pock­ets of extreme volatility.

The ques­tions for investors to ask are how and when to invest. We get into the “how” below. The answer to “when” is more straight­for­ward — imme­di­ately! Don’t delay, because every day is a good day to invest dur­ing a bull market.

ING Global Per­spec­tives Monthly Com­men­tary May 2012

Tags: April Fools, Armageddon, Bailout, Blockbuster, Chief Investment Strategist, Corporate Profits, Corporate Strength, Dutch Government, Earnings Growth, Euro Zone, Extreme Volatility, Fourth Year, Global Markets, Global Perspectives, Industrials, Ing Investment Management, Moderate Risk, Press Time, Quarter Earnings, Stampede
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Roller Coaster Returns (Sonders)

Wednesday, May 2nd, 2012

April 27, 2012

After an extended, and almost unprece­dented period of rel­a­tive calm, result­ing in robust stock mar­ket gains from Octo­ber 2011 through March 2012, we have seen some volatil­ity return. Con­cerns over global growth have reemerged as Chi­nese eco­nomic data has dis­ap­pointed, the Euro­pean debt cri­sis again is gain­ing head­lines as the mer­its of aus­ter­ity are being ques­tioned, and US eco­nomic data has been less impressive.

Volatil­ity has picked up

Source: Fact­Set, Chicago Board of Trade. As of Apr. 24, 2012.

One poten­tial ben­e­fit of this rise in con­ster­na­tion has been the long-awaited cor­rec­tion in stocks that many had been call­ing for. In fact, we have been com­forted by numer­ous investor sen­ti­ment read­ings now show­ing ele­vated bear­ish­ness (remem­ber that investor sen­ti­ment is a con­trary indi­ca­tor). The Amer­i­can Asso­ci­a­tion of Indi­vid­ual Investors’ (AAII) bull ratio recently moved decid­edly below the 50% mark for the first time in 2012. The per­cent­age of respon­dents say­ing they are bear­ish has moved from just under 28% to nearly 42% between April 4 and April 11; and the per­cent­age of bulls dropped to 28% from over 38% over the same time period. We believe this change in sen­ti­ment was needed in order for the mar­ket to reestab­lish a sus­tain­able uptrend going forward.

The recent mild increase in volatil­ity again reminds us that it's impor­tant to main­tain a long-term focus and to main­tain a diver­si­fied port­fo­lio. It's vital that investors review their port­fo­lio hold­ings on a reg­u­lar basis, while also look­ing at how cor­re­la­tions among asset classes change over time. A well-diversified port­fo­lio in one year may not be nearly so two years later, even if the posi­tions are roughly the same—the inter­ac­tion between asset classes changes over time. One final note on port­fo­lio con­struc­tion: The drum­beat of bear­ish bond com­men­tary has grown over the past month as yields remain near record lows. While we again remind investors that invest­ing in bonds for spec­u­la­tive or cap­i­tal appre­ci­a­tion pur­poses has become more risky; it is also true that for diver­si­fi­ca­tion, income, and cap­i­tal preser­va­tion pur­poses, bonds will still have a valu­able place in many port­fo­lios. Again, bal­ance is the key.

Macro con­cerns again trump­ing micro story

Investors' atten­tion is again focused on the macro rather than the micro over the past cou­ple of weeks—the height of first quar­ter earn­ings sea­son. The report­ing period has been much bet­ter than expected, although admit­tedly from a lower bar—83% of com­pa­nies have beaten expec­ta­tions so far, which is an all-time record high. But mar­ket reac­tions to good reports have been more muted rel­a­tive to the pun­ish­ments doled out to those that dis­ap­pointed. It appears Chi­nese devel­op­ments, Euro­pean debt and growth con­cerns, and some soft­en­ing in US eco­nomic data has led to increased volatility.

In the United States, the eco­nomic expan­sion con­tin­ues, but we may be in yet another soft spot. This isn't sur­pris­ing given the likely pulling for­ward of some eco­nomic activ­ity that was influ­enced by the unusu­ally warm weather dur­ing the win­ter months. We believe this is a rel­a­tively mod­est and tem­po­rary phe­nom­e­non and that activ­ity will again pick up in the com­ing months. Con­cern has grown that 2012 will be a repeat of the pre­vi­ous two years when the mar­ket declined begin­ning in April on soft­en­ing eco­nomic data after decent starts to the year. We believe the story is dif­fer­ent this time as jobs, lend­ing and hous­ing have improved and infla­tion has eased, allow­ing global cen­tral banks to keep pol­icy loose; lead­ing to our view that his­tory won't repeat this year.

Recently, we've seen regional man­u­fac­tur­ing sur­veys dis­ap­point, although remain­ing in ter­ri­tory depict­ing growth. The Empire Man­u­fac­tur­ing Index fell from 20.2 to 6.6 and the Philly Fed Index dropped to 8.5 from 12.5. Encour­ag­ingly, the employ­ment expec­ta­tion com­po­nent of Philly Fed jumped six points to its high­est level in a year, while March retail sales increased 0.8%, above esti­mates, indi­cat­ing that the Amer­i­can con­sumer remains engaged. Com­mod­ity costs have also lev­eled off recently, which should help to bol­ster dis­cre­tionary income.

Lower com­mod­ity prices should help consumers

Source: Fact­Set, Stan­dard & Poor's. As of Apr. 24, 2012.

Despite this still-positive pic­ture, recent job and hous­ing data has weak­ened a touch. The March pay­roll report dis­ap­pointed despite the unem­ploy­ment rate drop­ping and recent ini­tial job­less claims have crept a bit higher. We remain rel­a­tively uncon­cerned given that sea­sonal adjust­ments around the Easter hol­i­day can be dif­fi­cult and the level still remains well below the key 400,000 num­ber. Jobs are a vital cog in the econ­omy and we believe that increas­ing retail demand and a declin­ing abil­ity of com­pa­nies to squeeze addi­tional pro­duc­tiv­ity out of exist­ing work­ers should allow for con­tin­ued improve­ment on the labor front.

Tags: Austerity, Charles Schwab, Chicago Board Of Trade, Chief Investment Strategist, Dangerous Game, Debt Crisis, Earnings Season, Economic Data, Economic Forecasts, Election Season, Fed Meeting, Global Growth, Investor Sentiment, Liz Ann, Relative Calm, Roller Coaster, Sector Analysis, Senior Vice President, Stock Market Gains, Unprecedented Period
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James Paulsen: Investment Outlook (May 2012)

Wednesday, May 2nd, 2012

Is it Déjà Vu all Over Again?

April 30, 2012

by James Paulsen, Chief Invest­ment Strate­gist, Wells Cap­i­tal Man­age­ment (Wells Fargo)

After nearly six months of per­sis­tently better-than-expected eco­nomic reports and a reg­u­larly ris­ing stock mar­ket, met­rics on the econ­omy have turned a bit more mixed lately while stock mar­ket prices have strug­gled in recent weeks. This has caused many to won­der whether the econ­omy and the stock mar­ket are headed again toward another “spring swoon” like those expe­ri­enced dur­ing 2010 and 2011.

Spook­ily, con­di­tions do seem remark­ably sim­i­lar today to those which pre­ceded the last two spring thaws. In 2010, the stock mar­ket peaked on April 23 and in 2011 it peaked on April 29. Well, it’s April again and stocks are strug­gling? More­over, in each of the last two years, just like this year, the spring stalls were pre­ceded by improved eco­nomic reports and by a surge which car­ried stock prices to new recov­ery highs. Finally, ris­ing gas prices have again played a dom­i­nant role in recent months as they did lead­ing up to both of the last two spring swoons.

So, is every­one best advised to sim­ply “Sell in May and Go Away”—something which worked well in each of the last two years? Although sim­i­lar­i­ties to past swoons are trou­bling and while the recov­ery will inevitably “ebb and flow,” there are sev­eral crit­i­cal dif­fer­ences evi­dent this year which should help keep the econ­omy and the stock mar­ket out of “swoon’s way” dur­ing the bal­ance of 2012.

Eco­nomic Poli­cies are More Accommodative

Eco­nomic poli­cies are notably more accom­moda­tive today com­pared to either 2010 or 2011. In 2010, the pace of the M2 money sup­ply had slowed to a restric­tive 1 per­cent annual pace, and in early 2011 it was only ris­ing at a very mod­est 4 to 5 per­cent pace. By con­trast, today, the annual growth in the M2 money sup­ply has per­sisted about a robust 10 per­cent clip since last fall!

In both early 2010 and early 2011, the 30-year national aver­age mort­gage rate (Chart 1) rose above 5 per­cent prior to the spring swoons. Today, the mort­gage rate is near an all-time record low below 4 per­cent! Sig­nif­i­cant accel­er­a­tions in con­sumer infla­tion rav­ished house­hold real incomes prior to both the 2010 and 2011 eco­nomic stalls. As illus­trated in Chart 2, the annual rate of con­sumer price infla­tion jumped from –2 per­cent (defla­tion) in mid 2009 to about +2.5 per­cent by early 2010. Sim­i­larly, the annual infla­tion rate rose from about 1 per­cent at the end of 2010 to about 3.5 per­cent by 2011 spring­time. These spikes in con­sumer prices sig­nif­i­cantly reduced real house­hold income gains. Today, by con­trast, real incomes are being boosted by a decline in the con­sumer price infla­tion rate from about 4 per­cent last fall to 2.7 per­cent currently!

While the Japan­ese tsunami had rav­ished U.S. man­u­fac­tur­ing sup­ply chains last year, today the “Japan bounce” is help­ing revive U.S. indus­trial activ­ity. Finally, global eco­nomic pol­icy offi­cials are almost uni­ver­sally accom­moda­tive today. Until last fall, euro-zone offi­cials refused to ease inter­est rates or expand the ECB bal­ance sheet. Recently, how­ever, both poli­cies have been eased sig­nif­i­cantly! Sim­i­larly, until late last year, most emerg­ing world eco­nomic pol­icy offi­cials were attempt­ing to mod­er­ate recov­er­ies by tight­en­ing poli­cies. Now, nearly all of the emerg­ing world is eas­ing con­di­tions to reac­cel­er­ate recoveries.

In both 2010 and 2011, eco­nomic poli­cies were decid­edly more restric­tive and prob­a­bly played a sig­nif­i­cant role in the result­ing eco­nomic and stock mar­ket swoons. Today, how­ever, much more accom­moda­tive global eco­nomic poli­cies should bring a more favor­able outcome.

U.S. Eco­nomic Recov­ery More Mature

The spring swoon in 2010 hit before the eco­nomic recov­ery had even reached its first anniver­sary. Today, the recov­ery is much more mature and there­fore less vul­ner­a­ble to swoons than it was in either 2010 or 2011.

Sev­eral recent eco­nomic reports por­tray a matur­ing econ­omy. In the first quar­ter, aver­age monthly job gains were in excess of 200 thou­sand for the first time in this recov­ery. Ini­tial weekly unem­ploy­ment insur­ance claims have finally fallen below 400 thou­sand and the unem­ploy­ment rate is enjoy­ing its most per­sis­tent decline of the recov­ery. Addi­tion­ally, the present sit­u­a­tion con­sumer con­fi­dence index (Chart 3) has risen to a new recov­ery high, the econ­omy has enjoyed the most robust retail spend­ing of the recov­ery, auto sales have again recov­ered to about a 15 mil­lion annual pace, and an array of recent hous­ing reports sug­gest the great­est level of hous­ing activ­ity since the indus­try col­lapsed. Finally, bank loans (Chart 4), absent dur­ing much of the first two years of this recov­ery, have risen steadily dur­ing the last year!

While the eco­nomic recov­ery has not yet surged ahead with strong momen­tum, many of the tra­di­tional engines of growth which often sug­gest a sus­tain­able recov­ery (e.g., job cre­ation, con­sumer and busi­ness con­fi­dence, improve­ment in big ticket spend­ing propen­si­ties on cars and homes, and bet­ter bank lend­ing) are now increas­ingly evi­dent. With the econ­omy simul­ta­ne­ously fir­ing on so many more cylin­ders than it was in early 2010 or early last year, it appears much bet­ter equipped to weather adversities.

House­hold Fun­da­men­tals Much Improved

The U.S. house­hold is also much less vul­ner­a­ble to shocks com­pared to ear­lier in this recov­ery. Con­sumer fun­da­men­tals have improved markedly in the last year. The job mar­ket has finally come to life, con­sumer con­fi­dence has risen to its high­est level of the recov­ery, and real wages and salaries are ris­ing by about 2 per­cent in the last year com­pared to a neg­a­tive growth rate in early 2010. The U.S. per­sonal sav­ings rate has aver­aged 5.1 per­cent in the last four years which rep­re­sents the high­est per­sis­tent sav­ings rate in more than a decade, and the U.S. house­hold liq­uid­ity ratio (cash hold­ings as a per­cent of net worth) has been hov­er­ing about a 20-year high since the start of the recov­ery. More­over, despite vir­tu­ally no recov­ery yet in hous­ing prices, house­holds have already regained almost two-thirds of the loss in net worth expe­ri­enced dur­ing the crisis.

Tags: April 29, Chief Investment Strategist, Critical Differences, Dominant Role, Economic Policies, Economic Reports, Investment Outlook, M2, Market Metrics, Money Supply, Pace, Rising Gas Prices, Six Months, Spring Thaws, Stock Market Prices, Stock Prices, Swoon, Swoons, Wells Capital Management, Wells Fargo
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The Income Hunt: Opportunities Abroad

Wednesday, May 2nd, 2012

by Russ Koes­terich, Chief Invest­ment Strate­gist, iShares

Investors often have a home coun­try bias when it comes to their fixed income port­fo­lios, which means they are gen­er­ally too reliant on domes­tic issues. Today, how­ever, there are a num­ber of rea­sons why investors should con­sider main­tain­ing a strate­gic bench­mark allo­ca­tion to emerg­ing mar­ket debt.

In recent posts, I’ve high­lighted some of these argu­ments, includ­ing the increased sta­bil­ity and improv­ing fun­da­men­tals of emerg­ing mar­ket coun­tries. But since so many investors are ask­ing me lately about emerg­ing mar­ket debt, I fig­ured I’d expand on the case for this asset class in this post. Here’s a bit more on four argu­ments favor­ing expo­sure to emerg­ing mar­ket fixed income.

Bet­ter fis­cal posi­tions: Emerg­ing mar­kets exited the finan­cial cri­sis in a far bet­ter posi­tion than their devel­oped mar­ket coun­ter­parts. The aver­age debt bur­den of emerg­ing mar­kets is less than 40% of gross domes­tic prod­uct, while devel­oped mar­ket debt has soared to more than 100% of GDP on aver­age. This greater fis­cal sta­bil­ity is partly why emerg­ing mar­ket bonds should now be less volatile rel­a­tive to their devel­oped coun­ter­parts than in the past.

Fad­ing infla­tion risk: While investors in emerg­ing mar­kets were rea­son­ably con­cerned about infla­tion in 2011, infla­tion appears to be a fad­ing risk in most of the large emerg­ing mar­ket coun­tries, the excep­tion being India. Chi­nese infla­tion is cur­rently run­ning at 3.6%, roughly half the level of last July. In Rus­sia, infla­tion has fallen to 3.7% in March from nearly 10% last May. Even in Brazil, a coun­try with a his­tory of stub­bornly high infla­tion, con­sumer price infla­tion has dropped to 5.2% in March, down from 7.3% in Sep­tem­ber. Inter­na­tional Mon­e­tary Fund esti­mates sug­gest that this trend should con­tinue, with emerg­ing mar­ket infla­tion expected to fall through­out 2012.

High pre­mium: Despite emerg­ing mar­kets’ improv­ing fun­da­men­tals, emerg­ing mar­ket bonds are offer­ing a sig­nif­i­cant, and his­tor­i­cally high, pre­mium over most devel­oped mar­ket debt. Cur­rently, emerg­ing mar­ket bonds are yield­ing roughly 350 basis points over the 10-year Trea­sury, close to a record high.

Diver­si­fy­ing hedge: Emerg­ing mar­ket bonds add diver­si­fi­ca­tion and a hedge on the dol­lar, although they are more volatile than domes­tic bonds. And for those wish­ing to avoid the for­eign cur­rency expo­sure asso­ci­ated with inter­na­tional bonds, there are dol­lar denom­i­nated emerg­ing mar­ket bonds and funds that offer the incre­men­tal yields with­out the for­eign cur­rency risk.

In short, most investors are arguably under­weight emerg­ing mar­ket bonds in their fixed income port­fo­lios though there’s a strong case for con­sid­er­ing increas­ing expo­sure to this asset class through vehi­cles such as the iShares J.P. Mor­gan USD Emerg­ing Mar­kets Bond Fund (NYSEARCA: EMB) and the iShares Emerg­ing Mar­kets Local Cur­rency Bond Fund (NYSEARCA: LEMB).

Source: Bloomberg

Dis­clo­sure: Author is long EMB

Diver­si­fi­ca­tion may not pro­tect against mar­ket risk. Bonds and bond funds will decrease in value as inter­est rates rise. Inter­na­tional invest­ments may involve risk of cap­i­tal loss from unfa­vor­able fluc­tu­a­tion in cur­rency val­ues, from dif­fer­ences in gen­er­ally accepted account­ing prin­ci­ples or from eco­nomic or polit­i­cal insta­bil­ity in other nations. Emerg­ing mar­kets involve height­ened risks related to the same fac­tors as well as increased volatil­ity and lower trad­ing vol­ume. Nar­rowly focused invest­ments typ­i­cally exhibit higher volatil­ity and are sub­ject to greater geo­graphic or asset class risk. The Fund may be sub­ject to credit risk, which refers to the pos­si­bil­ity that the debt issuers will not be able to make prin­ci­pal and inter­est payments.

Tags: asset class, Bias, Chief Investment Strategist, Consumer Price Inflation, Counterparts, Debt Burden, Emerging Market Bonds, Emerging Market Countries, Emerging Markets, Estimates, Financial Crisis, Fiscal Positions, Fiscal Stability, Fixed Income, GDP, Gross Domestic Product, Inflation Risk, International Monetary Fund, Portfolios, Russ
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“Truth or Consequences?” (Saut)

Monday, April 30th, 2012

by Jef­frey Saut, Chief Invest­ment Strate­gist, Ray­mond James

April 30, 2012

“I have opted for more con­ser­v­a­tive ideas and not aggres­sive ones.”

After 28 years at this post, and 22 years before this in money man­age­ment, I can sum up what­ever wis­dom I have accu­mu­lated this way: The trick is not to be the hottest stock-picker, the win­ning fore­caster, or the devel­oper of the neat­est model; such vic­to­ries are tran­sient. The trick is to sur­vive. Per­form­ing that trick requires a strong stom­ach for being wrong, because we are all going to be wrong more often than we expect. The future is not ours to know. But it helps to know that being wrong is inevitable and nor­mal, not some ter­ri­ble tragedy, not some awful fail­ing in rea­son­ing, not even bad luck in most instances. Being wrong comes with the fran­chise of an activ­ity whose out­come depends on an unknown future (maybe the real trick is per­suad­ing clients of that inex­orable truth). Look around at the long-term sur­vivors at this busi­ness and think of the much larger num­ber of col­or­ful char­ac­ters who were once in the head­lines, but who have since dis­ap­peared from the scene.

The afore­men­tioned quote, from the bril­liant Peter Bern­stein (author, his­to­rian, econ­o­mist, and investor), hangs on the wall of my office, for in this busi­ness one is often wrong. But, as Bern­stein notes, “Being wrong comes with the fran­chise of an activ­ity whose out­come depends on an unknown future.” My redeem­ing fea­ture is that when I am wrong, I tend to be wrong quickly. Or as stated by William O’Neil, “The major­ity of unskilled investors stub­bornly hold onto their losses when the losses are small and rea­son­able. They could get out cheaply, but being emo­tion­ally involved and human, they keep wait­ing and hop­ing until their loss gets much big­ger and [that] costs them dearly.”

Indeed, we are always try­ing to man­age the “risks&rdquo inher­ent with invest­ing (or trad­ing), for as Ben­jamin Gra­ham wrote, “The essence of invest­ment man­age­ment is the man­age­ment of risks, not the man­age­ment of returns.” And that, ladies and gen­tle­men, is why we often “wait” on an invest­ment until its share price is at a point where if we are wrong, we will be wrong quickly, and hope­fully the inci­dence of “loss” will be small and man­age­able. To be sure, we always con­sider the con­se­quences of being wrong. This is when risk man­age­ment lives up to its real mean­ing. Again as Peter Bern­stein wrote in a New York Times article:

The key word is ‘con­se­quences.’ I learned this les­son many years ago from study­ing Blaise Pas­cal, a French math­e­mat­i­cal genius in the 17th cen­tury who spelled out the laws of prob­a­bil­ity more clearly than any­one before him. This was a thun­der­clap of an insight that, for the first time, gave human­ity a sys­tem­atic way of think­ing about the future. Pas­cal was both a gam­bler and a reli­gious zealot. One day he asked him­self how he would han­dle a bet on whether ‘God is or God is not.’ Rea­son could not answer. But, he said, we can choose between act­ing as though God is or act­ing as though God is not. Sup­pose we bet that God is, and we lead a life of virtue and absti­nence, and then the day of reck­on­ing comes and we dis­cover that there is no God. Well, life was still tol­er­a­ble even if less fun than we might have liked. Here, the con­se­quences of being wrong would be accept­able to most peo­ple. Sup­pose, how­ever, we bet that God is not, and lead a life of lust and sin, and then it turns out that God is. Now being wrong has put us into big trouble.

RISK man­age­ment, then, should be a process of deal­ing with the con­se­quences of being wrong. Some­times, these con­se­quences are min­i­mal – encoun­ter­ing rain after leav­ing home with­out an umbrella, for exam­ple. But bet­ting the ranch on the assump­tion that home prices can only go up should tell you the con­se­quences would be much more than min­i­mal if home prices started to fall.

To this “truth or con­se­quences” point, after being wildly bull­ish at the Octo­ber 4, 2011 “under­cut low” I turned cau­tious on the equity mar­kets in late Jan­u­ary when the “buy­ing stam­pede” ended. Since then I have been wait­ing for a price decline that would pro­duce another good risk-adjusted “buy point” like the ones iden­ti­fied on August 8th and 9th of last year, as well as the afore­men­tioned “under­cut low.” That does not mean I have not been fea­tur­ing cer­tain invest­ments when the risk/reward met­rics were deemed as being tipped decid­edly in our favor. Rather, I have opted for more con­ser­v­a­tive ideas and not aggres­sive ones. Case in point, in last week’s ver­bal strat­egy com­ments 3.5%-yielding Ray­onier (RYN/$45.51/Strong Buy) was again fea­tured with these com­ments from our fun­da­men­tal analyst:

We are upgrad­ing REIT Pri­or­ity List mem­ber Ray­onier to Strong Buy (from Out­per­form) as we believe RYN shares cur­rently offer one of the most com­pelling risk/reward pro­files in our REIT cov­er­age uni­verse. In our view, the under­per­for­mance of RYN shares year-to date (RYN shares are down 1%, while the RMZ and S&P 500 are both up 10%) present an attrac­tive entry-point for investors ahead of the company’s highly accre­tive cel­lu­lose spe­cial­ties expan­sion project, which is on track to come online in mid-2013.

Another name fea­tured was 7%-yielding LINN Energy (LINE/$39.86/Strong Buy). As stated by our fun­da­men­tal analyst:

The part­ner­ship deliv­ered another strong quar­ter beat­ing our EBITDA and dis­tri­b­u­tion cov­er­age fore­cast, prov­ing that not only does it know how to buy assets but it does a good job of oper­at­ing them too. Speak­ing of oper­a­tions, light­ning has now struck twice in the Gran­ite Wash with the partnership’s hor­i­zon­tal Hogshooter play hav­ing the poten­tial to be one of the high­est rate of return oil plays in the coun­try. Based on our con­tin­ued bull­ish out­look for the acqui­si­tion mar­ket, our fore­casted dis­tri­b­u­tion growth (5%+), and its solid hedge book, we reit­er­ate our Strong Buy rating.

Last week this con­ser­v­a­tive strat­egy looked some­what fool­ish (again) with the D-J Indus­tri­als (INDU/13228.31) up 1.53% and the S&P Small­Cap 600 Index (SML/462.02) bet­ter by 2.58%. The real weekly win­ner, how­ever, was Nat­ural Gas’ 9.67% sprint. The best per­form­ing macro sec­tors were: Finan­cials (+2.21%); Tech­nol­ogy (+2.56%); Energy (+2.67%); and Con­sumer Dis­cre­tionary (+2.76%). The Con­sumer Dis­cre­tionary per­for­mance is inter­est­ing because last week’s eco­nomic reports con­tinue to soften as of the 15 reports released only six were above esti­mates. Also dis­ap­point­ing were earn­ings reports with 65.6% of report­ing com­pa­nies beat­ing earn­ings esti­mates and 65.1% bet­ter­ing rev­enue esti­mates. This was a pretty big drop from the pre­vi­ous week’s ratio. Even more trou­bling is that for­ward earn­ings guid­ance turned neg­a­tive, which was a decided neg­a­tive swing week over week. The two sec­tors that have telegraphed the best for­ward earn­ings guid­ance are Health­care and Indus­tri­als. Mean­while, many of the indices I fol­low are break­ing down from what a tech­ni­cal ana­lyst would term a ris­ing wedge chart pat­tern (read: neg­a­tively), the D-J Trans­porta­tion Aver­age (TRAN/5267.39) con­tin­ues to strug­gle with its double-top often ref­er­enced in these com­ments (that would be negated by a move above ~5390), the NYSE McClel­lan Oscil­la­tor is back in over­bought ter­ri­tory (see the chart on page 3), the Buy­ing Power/ Sell­ing Pres­sure Indi­ca­tor sug­gests the rally from the April 10th low has been more about reduced sell­ing pres­sure rather than increased demand, the Oper­at­ing Com­pany Only Advance/Decline has never con­firmed the upside, and my weekly inter­nal energy indi­ca­tor still does not have enough energy to sup­port a new leg to the upside. Regret­tably, all of this con­tin­ues to leave me in cau­tious mode.

The call for this week: In this busi­ness when you’re wrong you say you’re wrong; at least that’s what the pros do. Clearly, I have been some­what wrong by being con­ser­v­a­tive, but not wrong by much because the INDU is actu­ally 70 points lower than where it was at the April 2, 2012 intra­day high. Given the afore­men­tioned litany of cau­tion­ary indi­ca­tors, my sense remains the S&P 500 (SPX/1403.36) will spend some more time below 1425 while the short-term over­bought con­di­tion is alle­vi­ated and the stock market’s inter­nal energy is rebuilt. Friday’s mar­ket action only rein­forced that belief with the indices gap­ping higher and then clos­ing well below those highs on lower volume.

Click here to enlarge

Tags: 22 Years, 28 Years, Bad Luck, Benjamin Graham, Chief Investment Strategist, Colorful Characters, Conservative Ideas, Economist, Forecaster, Franchise, Historian, Instances, jeffrey saut, Money Management, O Neil, Peter Bernstein, Raymond James, Stock Picker, Term Survivors, Truth Or Consequences
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“Dow Direction Dictates” (Saut)

Tuesday, April 24th, 2012

“Dow Direc­tion Dictates”

by Jef­frey Saut, Chief Invest­ment Strate­gist, Ray­mond James

April 23, 2012

“The absolute price of a stock is unim­por­tant. It is the direc­tion of price move­ment which counts.”

Dur­ing major sus­tained advances in stock prices, which usu­ally occupy from five to seven years of each decade, the investor can com­pla­cently hold a list of stocks which are cur­rently unpre­dictable. He doesn’t worry about the top because he knows he is never going to sell at the top. He knows that the chances are over­whelm­ing in favor of the assump­tion that he will get far bet­ter prices by wait­ing until after the top is passed and a prob­a­ble rever­sal in trend can be iden­ti­fied than he will ever get by attempt­ing to antic­i­pate the top, and get out on the nose.

In my own expe­ri­ence the largest prof­its we have ever taken have come from stocks pur­chased while they were mak­ing a new high in a mar­ket which was also momen­tar­ily expect­ing the top. As I have already pointed out the absolute price of a stock is unim­por­tant. It is the direc­tion of the price move­ment that counts. It is always prob­a­ble, but never cer­tain, that the direc­tion of the price move­ment will con­tinue. Soon after it reverses is time enough to sell. You should sell when you wish you had sold sooner, never when you think the top has arrived. That way you will never get the very best price—by hind­sight your indi­vid­ual trans­ac­tions will never look dar­ing. But some of your prof­its will be large; and your losses should be quite small. That is all that is nec­es­sary for a sat­is­fac­tory, enrich­ing invest­ment performance.

Stock Prof­its With­out Fore­cast­ing – by Edgar S. Genstein

These are two of the most impor­tant para­graphs I have encoun­tered in 45 years of study­ing mar­kets. DO NOT read them just once. Go off to a quiet spot that invites con­tem­pla­tion and READ THEM SEVERAL TIMES. Then reflect on all of the mis­takes you have made in trad­ing and invest­ing. Bells will ring, and curses will be uttered, if you are truly hon­est with your­self. My advice is to keep this quote handy, read it over, and study it every time you get ready to make an impor­tant buy or sell deci­sion; espe­cially if your emo­tions reign.

Obvi­ously, I agree with Mr. Genstein’s advice, but over the years have added a “twist” to his sage strat­egy. That twist has been to be a scale-up seller in select stocks that have appre­ci­ated when I think I should raise some cash. This does not mean I sell the entire posi­tion if I con­tinue to find the fun­da­men­tals to be favor­able. But, scale sell­ing par­tial posi­tions accom­plishes a num­ber of things. Firstly, it allows cap­i­tal gains to accrue to the port­fo­lio (some­times long-term cap­i­tal gains and some­times not). Sec­ondly, it rebal­ances said stock posi­tion back towards the orig­i­nal port­fo­lio weight­ing intended. Thirdly, it tends to give me the “mar­gin of safety” men­tioned in Ben­jamin Graham’s book “The Intel­li­gent Investor.” To wit, this strat­egy allows me to hold some of my orig­i­nal invest­ment posi­tions until I “wish I would have sold them sooner.”

I revisit this topic this morn­ing after spend­ing last week in Col­orado speak­ing at sev­eral events and see­ing insti­tu­tional accounts. Unsur­pris­ingly, most of the insti­tu­tions have had a dif­fi­cult time over the past few months. As one port­fo­lio man­ager put it, “While we make money in one posi­tion we give more than that back in another.” Indeed, since the “buy­ing stam­pede” ended on Jan­u­ary 26th it has been a mar­ket in which it has been pretty easy to lose money. For exam­ple, at the intra­day high of Jan­u­ary 26th the D-J Indus­trial Aver­age (INDU/13029.26) traded at ~12842. Last Fri­day the senior index closed at ~13029 for a 12-week gain of 0.015%. Mean­while, many indi­vid­ual stocks have fared far worse. As for retail investors, my pre­sen­ta­tions to them last week found most frozen like a deer in the head­lights of a car buf­feted by the recent decline and the neg­a­tive “spin” from the media; so let me address the recent action.

Recall that we advised rais­ing some cash fol­low­ing the ces­sa­tion of the “buy­ing stam­pede” in antic­i­pa­tion of a 5% — 8% pull­back in the major aver­ages. That said, our mantra was, “You can be cau­tious, but do not get bear­ish.” Some took that “raise cash” advice, but most did not, imbibed by the Dow’s 14.3% rally from mid-December, and its 23.4% rally since the Octo­ber 4, 2011 “under­cut low” that we actu­ally rec­om­mended buy­ing. Now, how­ever, the Dow’s 4.4% decline from its April 2nd peak into its April 10th reac­tion low has brought back mem­o­ries of last year’s May to August angst, which lopped 17.6% off the Indus­tri­als. While the recent news back­drop is less appeal­ing than that of Octo­ber – Feb­ru­ary, it is still not a rea­son to believe we are going to see another May through June swoon of over 17%. Let’s exam­ine why.

In the last tac­ti­cal bull mar­ket of Octo­ber 2002 through Octo­ber 2007 (60 months) there were nine such 4% or greater pull­backs, yet stocks traded higher after each cor­rec­tion. In the cur­rent tac­ti­cal bull mar­ket of March 2009 to present (37 months) there have already been eleven 4% or greater pull­backs and each time stocks have also sub­se­quently traded higher. Clearly the fre­quency of corrections/pullbacks has increased in the cur­rent cycle likely dri­ven by mem­o­ries of the Dow’s 54.4% mas­sacre between Octo­ber 2007 into the March 2009 bot­tom that at the time we deemed would be sim­i­lar to the “nom­i­nal” price-low of Decem­ber 1974 (that was the “nom­i­nal” price low of that wide-swinging, trading-range 1965 – 1982 affair). More recently, we have likened last year’s Octo­ber 4th “under­cut low” to the valuation-low that occurred in August 1982 since val­u­a­tions last Octo­ber were at lev­els not seen in decades. Whether we have begun a sec­u­lar bull mar­ket like that of August 1982 – Jan­u­ary 2000 is debat­able, but we doubt last October’s low will be violated.

Nev­er­the­less, since the begin­ning of Feb­ru­ary there have been a num­ber of glean­ings that left us in cau­tious mode. The parade looks like this: an upside non-confirmation by the D-J Trans­ports (TRAN/5234.25), the small-caps also failed to con­firm the upside with the Rus­sell 2000 (RUT/804.05) sub­se­quently expe­ri­enc­ing a 7.5% decline, weak­ness in the market-leading Finan­cial SPDR Fund (XLF/$15.18), wors­en­ing Advance/Decline and New High/New Low fig­ures, a 90% Down­side Day on April 10th, wan­ing Buy­ing Power, an exhaus­tion of the stock market’s weekly inter­nal energy, soft­en­ing eco­nomic reports, and the list goes on. On the pos­i­tive side: the stock market’s daily inter­nal energy has a full charge of energy, an 8.53% drop in the price of gaso­line last week, an earn­ings report­ing sea­son that has so far seen 72% of com­pa­nies beat­ing esti­mates and 70% beat­ing rev­enue esti­mates (more impor­tantly, after two quar­ters of reduc­ing guid­ance com­pa­nies are now rais­ing future earn­ings guid­ance), late Fri­day the IMF announced it has raised another $430 bil­lion to be used if Euro­quake wors­ens, a U.S. dol­lar that looks like it is break­ing down (read: a pos­i­tive for stocks), and hereto the list goes on. All of this con­tin­ues to leave us chant­ing, “You can be cau­tious, but do not get bearish!”

This week we will see more major com­pa­nies report­ing earn­ings. From our research uni­verse, stocks that are favor­ably rated by our fun­da­men­tal ana­lysts and appear pos­i­tive on our pro­pri­etary algo­rithms are: Brinker (EAT/$27.90/Strong Buy); Baidu (BIDU/$144.91/Strong Buy); Pul­te­group (PHM/$8.37/Outperform); and Cater­pil­lar (CAT/$107.73/Outperform – cov­ered by Ray­mond James Ltd.).

The call for this week: For the past few weeks I have wrongly sug­gested that my sense is the S&P 500 (SPX/1378.53) will remain mired in the 1385 – 1425 con­sol­i­da­tion zone. As paraphrased:

I think the SPX needs to con­va­lesce in the 1385 – 1425 zone while the short-term over­bought con­di­tion is alle­vi­ated and the market’s inter­nal energy is rebuilt. Inter­est­ingly, while my daily inter­nal energy indi­ca­tor now has more than a full charge of energy, the weekly energy indi­ca­tor is nowhere near being fully recharged. The impli­ca­tion is that the down­side should be con­tained, but the SPX is also not likely to break­out above 1425 with­out spend­ing more time con­sol­i­dat­ing. ... Impor­tantly, all of the pull­backs in the SPX this year have been between 25 and 35 points. Accord­ingly, mea­sur­ing from the recent reac­tion high of ~1419 pro­duces a level of 1394 for a 25-point cor­rec­tion, and 1384 for a 35-pointer. Hence, any­thing more than a 45-point pull­back would put the SPX below the bot­tom of our 1375 – 1385 sup­port zone and sug­gest some­thing has changed, poten­tially bring­ing into view the 1320 – 1340 zone.

Sub­se­quently, the SPX dropped below that envi­sioned zone, yet has ral­lied back into the 1375 – 1385 zone, which has now become an over­head resis­tance level. And for these rea­sons we coun­seled for cau­tion before leav­ing for Col­orado last week. Our advice was not to sell short, not to add to exist­ing long posi­tions, not to raise cash since we have already raised cash, but rather to sit tight because the down­side should be con­tained in the 1320 – 1340 zone. Con­fi­dence that down­side objec­tive will be achieved grows if the April 10th intra­day low of 1357.38 is vio­lated. And this morn­ing that pivot point looks like it is going to be tested with the pre­open­ing futures off some 14 points. Indeed, “The absolute price of a stock is unim­por­tant. It is the direc­tion of price move­ment which counts.”

Copy­right © Ray­mond James

Tags: 45 Years, Assumption, Bells, Chief Investment Strategist, Contemplation, Curses, Dow, Edgar, Hindsight, Investment Performance, jeffrey saut, Nbsp, Paragraphs, Performance Stock, Quiet Spot, Raymond James, Seven Years, Several Times, Stock Prices, Stock Profits
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Concern or Correction?

Wednesday, April 18th, 2012

April 13, 2012

by Liz Ann Son­ders, Senior Vice Pres­i­dent, Chief Invest­ment Strate­gist, Charles Schwab & Co., Inc.,
and Brad Sorensen, CFA, Direc­tor of Mar­ket and Sec­tor Analy­sis, Schwab Cen­ter for Finan­cial Research,
and Michelle Gib­ley, CFA, Direc­tor of Inter­na­tional Research, Schwab Cen­ter for Finan­cial Research

Key Points

• Eco­nomic data has soft­ened a bit lately but still indi­cates growth in the United States. After a long stretch of rel­a­tive calm in the mar­kets, we've seen the mar­kets pull back, pos­si­bly ful­fill­ing the cor­rec­tion that was over­due. We believe the longer-term trend is higher but near-term risks con­tinue to be ele­vated and earn­ings sea­son could bring more volatility.
• After a cou­ple weeks of shift­ing per­cep­tions regard­ing what the Fed's next move may be, the min­utes from the most recent meet­ing seemed to solid­ify the notion that another round of quan­ti­ta­tive eas­ing (QE3) is not in the off­ing. Although the stock and bond mar­kets ini­tially reacted neg­a­tively, we are heart­ened by the rhetoric.
• Euro­pean debt fears have flared up again in Spain and Italy and we believe risks are ele­vated and may not be fully appre­ci­ated. Mean­while, China's response to slow­ing growth has been sur­pris­ingly slow and risks of a mis­step are ris­ing, although we still remain opti­mistic in the longer term.

After the best first quar­ter stock per­for­mance since 1998, based on the S&P's 12% return, and the recent pull­back in the mar­kets, investors may be won­der­ing what’s next. Can the mar­ket resume its move higher? Was the cor­rec­tion enough to heal over­bought con­di­tions and ele­vated investor sen­ti­ment? What will be the cat­a­lyst for the next move?

There hasn't been a short­age of com­men­tary sug­gest­ing that a pull­back in equi­ties was over­due and needed for the next leg higher. But now that we've seen a pull­back, con­cerns are sud­denly grow­ing that we could be in for an extended down­turn. Although risks are ele­vated, cur­rently we don’t believe the cor­rec­tion to-date rep­re­sents a shift in the recent upward trend in stocks. In fact, we can look back at sim­i­lar peri­ods and find some heart­en­ing infor­ma­tion. Accord­ing to our friend Ed Yardeni at Yardeni Research there have been 17 times in the last 66 years that each of the first three months have posted pos­i­tive S&P 500 returns. The aver­age total yearly return for those 17 years was 20.2%, with none of those years post­ing a neg­a­tive return. But with such a great head start, that might not be all that mean­ing­ful for the rest of the year. How­ever, accord­ing to Ned Davis Research, there have been 11 instances since 1930 where the S&P 500 posted returns above 10% in the first quar­ter. The median return for the fol­low­ing three quar­ters was 6.95%, with all but two post­ing pos­i­tive returns for that time period.

Addi­tion­ally, the recent cor­rec­tion has helped push the Ned Davis Research Daily Sen­ti­ment Com­pos­ite into exces­sive pes­simistic ter­ri­tory, sharply revers­ing the overly opti­mistic sen­ti­ment seen just a few weeks ago. Neg­a­tive investor sen­ti­ment has tended to be a con­trary indi­ca­tor and we believe is a pos­i­tive devel­op­ment for the mar­ket as we move forward.

One more bit of his­toric data regard­ing the inter­play between stocks and bonds. Bonds have had a decade-long run that has seen inter­est rates sink to his­tor­i­cally low lev­els and we have warned investors that may be over­al­lo­cated to bonds that a rever­sal to the mean may be in store. Cap­i­tal appre­ci­a­tion on bonds is by def­i­n­i­tion capped as inter­est rates can only go to zero, which we’re not that far away from on Trea­sury secu­ri­ties. Fur­ther­ing that warn­ing, accord­ing to Bespoke Invest­ment Group, when equi­ties have out­per­formed bonds sub­stan­tially (above 10%) for two quar­ters in a row, which just occurred and has hap­pened nine pre­vi­ous times, the aver­age equity return in the fol­low­ing quar­ter has been 4.6%, while bonds have aver­aged a decline of 0.5%. And we may be see­ing that shift from bonds to equi­ties begin as the week ended March 23^rd, accord­ing to EPFR Global, saw out­flows from long-term gov­ern­ment bond funds of $1.01 bil­lion, the largest amount on record (thanks to Barron’s for point­ing this out). How­ever, we must cau­tion investors that are invest­ing in bonds and bond funds for income pur­poses that they still remain the most appro­pri­ate pre­dictable income invest­ment vehi­cle in most cases, and the vast major­ity of investors should main­tain at least some expo­sure to bonds based on income needs and risk tolerances.

Earn­ings to take the reins?

Recent US eco­nomic data has raised some ques­tions among investors as to the sus­tain­abil­ity of the eco­nomic expan­sion. We share some of those con­cerns as con­fi­dence remains ten­u­ous, the polit­i­cal sit­u­a­tion is messy, the Euro­pean debt cri­sis rages on, and Chi­nese growth has slowed. But we main­tain con­fi­dence that the eco­nomic expan­sion is con­tin­u­ing and should con­tinue for the fore­see­able future. The Insti­tute for Sup­ply Management's (ISM) man­u­fac­tur­ing sur­vey rose to 53.4, with a read­ing above 50 indi­cat­ing expan­sion. Addi­tion­ally, the employ­ment com­po­nent moved to 56.1 from 53.2, and while new orders dropped slightly, it still remains solidly above 50. The ser­vice side of the ledger also con­tin­ues to show expan­sion as the ISM Non-Manufacturing Index posted a read­ing of 56.0.

The job pic­ture got a lit­tle murkier with the lat­est report. Although ADP reported that March pri­vate pay­rolls expanded by 209,000 posi­tions and Feb­ru­ary was revised higher, the Labor Depart­ment said that only 120,000 jobs were added, below expec­ta­tions and con­tribut­ing to the pull­back in stocks. Pos­i­tively, the unem­ploy­ment rate dropped to 8.2%, still ele­vated but well off its high. Lead­ing indi­ca­tors of job growth such as ini­tial unem­ploy­ment claims con­tinue to sug­gest that the March read­ing may prove to be an out­lier and/or a nat­ural pull­back after the strong weather-related gains in the first two months.

In fact, the improv­ing job pic­ture appears to be bol­ster­ing the con­sumer, as retail sales num­bers have been rel­a­tively pos­i­tive and we’ve seen auto sales con­tinue to rebound after a sharp drop-off.

Auto sales indi­cate increased confidence

Source: Fact­Set, U.S. Bureau of Eco­nomic Analy­sis. As of April 10, 2012.

And we'll be get­ting more infor­ma­tion at the cor­po­rate level over the next sev­eral weeks as first quar­ter earn­ings sea­son heats up. There appears to be more uncer­tainty head­ing into this sea­son than we've seen recently, but we have seen ana­lyst fore­casts revised higher recently. This report­ing sea­son could pro­vide the next near-term cat­a­lyst for the mar­kets as some pos­i­tive sur­prises and com­men­tary could pro­vide fur­ther fuel, while dis­ap­point­ment could move stocks lower. One advan­tage we may have is that expec­ta­tions enter­ing the sea­son appear rel­a­tively low, with Yardeni report­ing that as of April 6 ana­lysts are expect­ing S&P 500 com­pa­nies' earn­ings to only grow 2.4% over last year, which would be the slow­est rate since the third quar­ter of 2009, pro­vid­ing the oppor­tu­nity for upside sur­prises. Addi­tion­ally, accord­ing to Strate­gas Research Part­ners, the negative-to-positive pre­an­nounce­ment ratio was 3.0 for the first quar­ter and they note that when the ratio has been above 2.1, the stock mar­ket in the month after the end of the quar­ter has risen 2.2%, while declin­ing 0.3% when the ratio is below 2.1. One thing we'll be con­tin­u­ing to watch will be com­men­tary sur­round­ing the mas­sive cash that being stored on bal­ance sheets and how it may be used in the future.

Cor­po­rate liq­uid­ity near an all-time high

Source: Fact­Set, Fed­eral Reserve. As of April 10, 2012.

Fed con­tin­ues to confound

The above chart helps to illus­trate why we believe that another round of quan­ti­ta­tive eas­ing (QE3) seems unnec­es­sary. There is plenty of liq­uid­ity in the econ­omy and pump­ing more in would seem to us to do lit­tle good. It appears the Fed­eral Reserve may be start­ing to move toward that view as well, or at least they're becom­ing more con­fi­dent in the eco­nomic recov­ery. The recently released min­utes from their March meet­ing indi­cates that there isn't much appetite on the Com­mit­tee for QE3. Although stocks and bonds had an ini­tial neg­a­tive response, much like a child wob­bling on a bike after a par­ent lets go for the first time, we believe Fed sup­port needs to slowly be with­drawn so the econ­omy can ride on its own.

Euro­pean debt risks flare up

Con­trar­ily, The Euro­pean Cen­tral Bank (ECB) appears anx­ious to shove its kid on a bike as soon as pos­si­ble with lagged and tepid responses to the ongo­ing debt cri­sis. That said, its three-year loan liq­uid­ity injec­tions early this year did buy time for banks and gov­ern­ments and reduced the immi­nent threat of a bank­ing sys­tem col­lapse. How­ever, the sugar high may have lulled investors into a false sense of secu­rity, as the euro­zone debt cri­sis was merely put on pause.

While it may be an over­sim­pli­fi­ca­tion, the ele­va­tion to a cri­sis sit­u­a­tion boils down to con­fi­dence. Loss of con­fi­dence can become a self-fulfilling proph­esy, as we wit­nessed with Lehman Broth­ers in 2008. There­fore, in order to main­tain investor con­fi­dence, Euro­pean pol­i­cy­mak­ers have to con­tinue to make progress toward reduc­ing deficits, meet­ing fis­cal tar­gets, mak­ing struc­tural changes to pro­vide a foun­da­tion for growth, and imple­ment back­stops in case things deteriorate.

How­ever, instead of mak­ing progress, con­fi­dence is being slowly eroded by back­ward moves:

• In Italy, Prime Min­is­ter Mario Monti’s labor reform pro­posal has been watered down.
• France’s pres­i­den­tial elec­tion on April 22 and May 6 could result in a change of lead­er­ship to pres­i­den­tial can­di­date Fran­cois Hol­lande, who has pledged to rene­go­ti­ate the euro­zone fis­cal pact.
• Greece’s gen­eral elec­tion, which could occur around May 6, could result in a weak coali­tion gov­ern­ment, increas­ing the pos­si­bil­ity of missed quar­terly bailout fund­ing targets.
• Even the Nether­lands, con­sid­ered a core coun­try and a strong pro­po­nent of fis­cal dis­ci­pline, admit­ted it too would run afoul of the Euro­pean Union’s 3% deficit tar­get in 2012, result­ing in the need for aus­ter­ity cuts.

But due to the size of its econ­omy and debts, weak eco­nomic out­look and bank­ing sys­tem, Spain is the ele­phant in the room that can­not be ignored. Euro­zone debt con­cerns flared up after Spain announced it would miss its 2012 deficit target.

The Span­ish econ­omy has an uncer­tain and risky out­look as evi­denced by unem­ploy­ment still ris­ing from an already high 24% and a hous­ing bub­ble that is still deflat­ing. Addi­tion­ally, pri­vate sec­tor debt in Spain grew dra­mat­i­cally dur­ing the hous­ing boom and the risk is that Span­ish banks could face more prob­lems in the future because losses on pri­vate sec­tor debt are likely to rise. As a result, bank prob­lems could be inher­ited by the sov­er­eign, because banks could need gov­ern­ment aid.

The inter­ac­tion between the econ­omy, the banks and the sov­er­eign can feed off each other and exac­er­bate the sit­u­a­tion, and it may take only a minor dete­ri­o­ra­tion in one or two areas for a neg­a­tive spi­ral to take effect in Spain. We believe Span­ish banks likely need more cap­i­tal as a buffer, but we don’t believe Spain’s gov­ern­ment is in immi­nent need of a bailout. How­ever, mar­kets are ner­vous that Spain’s sit­u­a­tion could dete­ri­o­rate, neces­si­tat­ing a bailout over the next cou­ple years.

Euro­zone con­cerns remain, par­tic­u­larly for Spain

Source: Fact­Set, iBoxx. As of Apr. 10, 2012.

We are dis­cour­aged that the com­bi­na­tion of dete­ri­o­ra­tion in Spain and the ECB reit­er­a­tion that emer­gency mea­sures are tem­po­rary has been able to have such a large impact on Ital­ian yields. While the region's bailout funds were some­what boosted by com­bin­ing the tem­po­rary Euro­pean Finan­cial Sta­bil­ity Facil­ity (EFSF) with the longer-term Euro­pean Sta­bil­ity Mech­a­nism (ESM) for a year, an even big­ger fire­wall may be needed.

Global growth moderating

The focus on aus­ter­ity in the euro­zone misses the need to fos­ter the absent ingre­di­ent– growth. Eco­nomic releases over the past month have shown a gen­er­al­ized renewed eco­nomic weak­ness in Europe and con­tin­ued declines in credit indi­cate growth will be dif­fi­cult to achieve.

Mean­while, the Asia/Pacific region is also under down­side pres­sure. As dis­cussed later, China’s econ­omy con­tin­ues to soften. Many Asian nations have close ties to the Chi­nese econ­omy, and a slow­down in com­modi­ties and goods exports to China is reduc­ing their growth.

As for Japan, the world's third largest econ­omy, eco­nomic data has been mixed. Japan's lead­ing index has con­tin­ued to trend higher and there has been a recent rebound in machin­ery orders. How­ever, Japan­ese house­hold spend­ing remains weak and despite an increase in the Bank of Japan's (BoJ) asset pur­chase pro­gram in Feb­ru­ary, money sup­ply dropped in March, and the quar­terly Tankan sur­vey showed busi­ness con­fi­dence has failed to improve. In con­trast to the BoJ hold­ing off on new mea­sures in its April meet­ing, we believe the BoJ needs to do more and make good on its promise of pur­su­ing “pow­er­ful eas­ing” to cre­ate infla­tion and weaken the yen.

Like­wise, some­what dis­heart­en­ing is a slight change in tone by cen­tral banks else­where. For exam­ple, despite down­side risks to eco­nomic growth, the Reserve Bank of Aus­tralia and the ECB also held off on eas­ing at their recent meet­ings amid signs of infla­tion pick­ing up. We believe infla­tion pres­sures will con­tinue to ease glob­ally as we move through the year, as food prices have fallen and oil prices could have down­side risks as global growth slows and geopo­lit­i­cal pres­sures ease. This could give cen­tral banks more lee­way to ease in the future.

China con­tin­ues to slow, but crash unlikely

We believe mar­kets had been under­es­ti­mat­ing the risks in Europe and over-emphasizing the pos­si­bil­ity of a hard land­ing in China. Growth has slowed, but has defied the bear­ish calls for a crash. How­ever, mon­e­tary eas­ing has been dis­ap­point­ingly slow. We had believed that a sharp drop in infla­tion and money sup­ply would allow stim­u­lus to be enacted sooner. Typ­i­cally an econ­omy needs growth in money sup­ply and lend­ing to grow. Money sup­ply has been grow­ing at a slower pace than nom­i­nal eco­nomic growth, pres­sur­ing eco­nomic growth.

China likely slows amid mod­est money sup­ply growth

Source: Fact­Set, National Bureau of Sta­tis­tics of China, People's Bank of China. As of Apr. 10, 2012.
* Excess liq­uid­ity is M2 money sup­ply less nom­i­nal GDP

The Chi­nese gov­ern­ment is play­ing a bal­anc­ing game that has increas­ing risks of mis­steps. We are encour­aged by early signs of a reac­cel­er­a­tion in lend­ing that could boost eco­nomic growth. Else­where, the gov­ern­ment is try­ing to reduce imbal­ances in the econ­omy and tran­si­tion away from depen­dence on exports as well as build­ing fac­to­ries and infra­struc­ture. While remov­ing imbal­ances may be good over the long-term, the abil­ity of the gov­ern­ment to micro-manage an econ­omy that is now the world's sec­ond largest is becom­ing more dif­fi­cult. Real progress toward a tran­si­tion is likely to require tough polit­i­cal deci­sions and reforms, and mis­cues could make for a bumpy ride.

Read more inter­na­tional research at www.schwab.com/oninternational.

Impor­tant Disclosures

The MSCI EAFE® Index (Europe, Aus­trala­sia, Far East) is a free float-adjusted mar­ket cap­i­tal­iza­tion index that is designed to mea­sure devel­oped mar­ket equity per­for­mance, exclud­ing the United States and Canada. As of May 27, 2010, the MSCI EAFE Index con­sisted of the fol­low­ing 22 devel­oped mar­ket coun­try indexes: Aus­tralia, Aus­tria, Bel­gium, Den­mark, Fin­land, France, Ger­many, Greece, Hong Kong, Ire­land, Israel, Italy, Japan, the Nether­lands, New Zealand, Nor­way, Por­tu­gal, Sin­ga­pore, Spain, Swe­den, Switzer­land and the United Kingdom.The MSCI Emerg­ing Mar­kets Index^SM is a free float-adjusted mar­ket cap­i­tal­iza­tion index that is designed to mea­sure equity mar­ket per­for­mance in the global emerg­ing mar­kets. As of May 27, 2010, the MSCI Emerg­ing Mar­kets Index con­sisted of the fol­low­ing 21 emerging-market coun­try indexes: Brazil, Chile, China, Colom­bia, the Czech Repub­lic, Egypt, Hun­gary, India, Indone­sia, Korea, Malaysia, Mex­ico, Morocco, Peru, Philip­pines, Poland, Rus­sia, South Africa, Tai­wan, Thai­land and Turkey.The S&P 500® index is an index of widely traded stocks.Indexes are unman­aged, do not incur fees or expenses and can­not be invested in directly.Past per­for­mance is no guar­an­tee of future results.Investing in sec­tors may involve a greater degree of risk than invest­ments with broader diversification.International invest­ments are sub­ject to addi­tional risks such as cur­rency fluc­tu­a­tions, polit­i­cal insta­bil­ity and the poten­tial for illiq­uid mar­kets. Invest­ing in emerg­ing mar­kets can accen­tu­ate these risks.The infor­ma­tion con­tained herein is obtained from sources believed to be reli­able, but its accu­racy or com­plete­ness is not guar­an­teed. This report is for infor­ma­tional pur­poses only and is not a solic­i­ta­tion or a rec­om­men­da­tion that any par­tic­u­lar investor should pur­chase or sell any par­tic­u­lar secu­rity. Schwab does not assess the suit­abil­ity or the poten­tial value of any par­tic­u­lar invest­ment. All expres­sions of opin­ions are sub­ject to change with­out notice.The Schwab Cen­ter for Finan­cial Research is a divi­sion of Charles Schwab & Co., Inc.

Copy­right © Charles Schwab & Co., Inc.,

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“Be Conservative, Not Conventional!” (Saut)

Tuesday, April 17th, 2012

“Be Con­ser­v­a­tive, Not Conventional!”

by Jef­frey Saut, Chief Invest­ment Strate­gist, Ray­mond James

April 16, 2012

Here’s the para­dox: the odds are over­whelm­ing I will end up richer by aim­ing for a good return rather than a bril­liant return – and sleep bet­ter en route. Folks who seek a killing usu­ally get killed. Gun­slingers get shot, and often in the foot, with their own guns. While there is always some guy around on a red-hot streak, his main func­tion is to tempt the rest of us into becom­ing fools and pau­pers. A return of 15% to 20% annu­ally is a lot more than most folks real­ize, or need. If a 30-year old with $10,000 in an IRA gets 15% annu­ally, he’ll be a mil­lion­aire before nor­mal retire­ment. That’s the power of com­pound inter­est. If that same 30-year old were to sock away another $2,000 per year at 15%, he would end up as a 65-year old $3 mil­lion fat cat. At 20%, it’s an incred­i­ble $13 mil­lion. That’s a lot, but it’s not too much to ask. The two most defin­i­tive stud­ies ever on long-term returns, the Ibbotson/Sinquefield and Fisher/Lorie stud­ies, both point to aver­age annual returns for stocks of 9% plus per year going back to the mid-1920s. So 15% to 20% per year is really 66% to 100% bet­ter than the mar­ket as a whole. That’s tough but doable. Con­sis­tency is the key. It is close to impos­si­ble to get a good, long-term, rate of return if you suf­fer seri­ous neg­a­tive num­bers en route. It’s the math. A sin­gle year that is down 30% means you have to get 30% per year pos­i­tive returns for the next four years to get back on track for a 15% annual aver­age. Or, if you score 20% annu­ally for four years, and then suf­fer a 30% decline, your five-year aver­age return is only 7%.

... Ken Fisher, Forbes, 1989

I have often repub­lished Ken Fisher’s sage advice ever since first read­ing it in 1989 because it speaks to the cen­ter­piece of my invest­ment phi­los­o­phy. To wit, “The odds are over­whelm­ing I will end up richer by aim­ing for a good return rather than a bril­liant return – and sleep bet­ter en route.” Or as Ben­jamin Gra­ham wrote, “The essence of invest­ment man­age­ment is the man­age­ment of RISKS, not the man­age­ment of RETURNS.” Indeed, if you man­age the down­side the upside will take care of itself. Avoid­ing the big loss is, and always has been, the key to invest­ment suc­cess. Accord­ingly, when the odds are not tipped in my favor I tend to not be very aggres­sive, a stance I took a few months ago.

Recall, it was around the end of Jan­u­ary that, at least by my work, the “buy­ing stam­pede” ended when the D-J Indus­trial Aver­age (INDU/12849.59) closed lower for four con­sec­u­tive ses­sions. Inter­est­ingly, at the “buy­ing stampede’s” intra­day peak of Jan­u­ary 26th the senior index changed hands at ~12842. At last week’s intra­day low it was some 131 points below that level, con­sis­tent with my state­ment, “Except for a few stocks, I don’t see where a whole lot of money has been made since the end of Jan­u­ary.” Given that strat­egy, I have pre­ferred to focus on select mutual funds and exchange-traded prod­ucts with “con­ser­v­a­tive not con­ven­tional” invest­ment styles. One such mutual fund is Gold­man Sachs’ Ris­ing Div­i­dend Growth Fund (GSRAX/$14.85), whose invest­ment style is to invest in com­pa­nies that increase their div­i­dends by 10% per year on aver­age for 10 years in a row. Accord­ingly, the fund seeks cap­i­tal appre­ci­a­tion and cur­rent income. Another invest­ment idea is the Yorkville High Income MLP ETF (YMLP/$19.53). YMLP is struc­tured for an out­sized cur­rent yield by invest­ing in mas­ter lim­ited part­ner­ships. Yet because of that struc­ture no tax-cumbersome K-1 is issued since the div­i­dend dis­tri­b­u­tions are clas­si­fied as return of prin­ci­pal. Granted, my con­ser­v­a­tive stance looked pretty fool­ish when the INDU tagged ~13265 on April 2nd, but has not looked as fool­ish since then with the Dow sur­ren­der­ing roughly 4% into last week’s lows. That declined sparked the ques­tion, “Hey Jeff, is the cor­rec­tion over?”

Well, as repeat­edly chron­i­cled in these com­ments, all of the pull­backs in the S&P 500 (SPX/1370.26) this year have been between 25 and 35 points. Accord­ingly, mea­sur­ing from the recent clos­ing reac­tion high of 1419.04 pro­duces a level of 1394 for a 25-point cor­rec­tion, and 1384 for a 35-pointer. Impor­tantly, any­thing more than a 45-point pull­back would put the SPX below the bot­tom of our 1375 – 1385 sup­port zone and thus would sug­gest some­thing has changed. It would also rep­re­sent a break­down below a spread triple-bottom for most of the major aver­ages. While there is minor sup­port around 1360 – 1365, my hunch is that break­ing below 1375 brings into view the 1320 – 1340 level. Nev­er­the­less, com­ing into last week I thought the SPX would remain mired in the 1385 – 1425 con­sol­i­da­tion zone while the short-term over­bought con­di­tion was alle­vi­ated and the stock market’s inter­nal energy was rebuilt. And at last week’s low the NYSE McClel­lan Oscil­la­tor was indeed back in a fully over­sold posi­tion. More­over, my daily inter­nal energy indi­ca­tor also had more than a full charge of energy. There­fore, at Tuesday’s lows one should have expected some kind of “throw­back rally,” and that’s exactly what we got. Unfor­tu­nately, Friday’s Fade left the SPX back below the afore­men­tioned 1375 – 1385 zone and con­se­quently still vul­ner­a­ble. This would be espe­cially true if last week’s lows at ~1358 are breached this week.

Since the SPX’s April 2nd peak the two worst per­form­ing sec­tors have been Energy and Finan­cials, which have fallen more than 5%. While this is not sur­pris­ing for Energy, because that group did not act well dur­ing the entire 1Q12 rally, Finan­cials was one of the best per­form­ing sec­tors of the quar­ter, sug­gest­ing their weak­ness since early April may be telegraph­ing a change in the invest­ment envi­ron­ment. Also con­cern­ing was last week’s 17% leap in the Finan­cials’ Credit Default Risk Index. Then there was market-leading Apple’s (AAPL/$605.23) weak­ness over the past four ses­sions, a four-day down­side skein not seen since last year. With such “tells,” and given the fact that the INDU and SPX have fallen below not only their envi­sioned sup­port zones, but their respec­tive 50-DMAs, we con­tinue to coun­sel for cau­tion, believ­ing early this week should pro­vide bet­ter clar­ity on the near term direc­tion­al­ity of stock prices. Ver­ily, “Be Con­ser­v­a­tive Not Conventional!”

The call for this week: Earn­ings sea­son com­menced last week with 75% of the report­ing com­pa­nies beat­ing esti­mates. This week will show increased earn­ings reports with many of the major com­pa­nies report­ing. Our sense is the earn­ings envi­ron­ment will con­tinue to be pretty good, which should limit the stock market’s down­side to the 1320 – 1340 level. More­over, the SPX held above its weekly uptrend chart line at 1358 last week, leav­ing the tech­ni­cal setup not as vul­ner­a­ble as it was in May 2011. How­ever, the Decem­ber to late Jan­u­ary upside run­away appears to be over until the stock market’s weekly inter­nal energy is rebuilt. Unfor­tu­nately, the weekly inter­nal energy indi­ca­tor is nowhere near being fully recharged. The impli­ca­tion is that the down­side should be con­tained, but the SPX is also not likely to break out above 1425 with­out spend­ing some more time consolidating.

P.S. – I am in Col­orado this week and will return next week.

Copy­right © Ray­mond James

Tags: Centerpiece, Chief Investment Strategist, Consistency, Definitive Studies, Fat Cat, Fools, Forbes, Hot Streak, Investment Philosophy, jeffrey saut, Ken Fisher, Lorie, Mid 1920s, Millionaire, Negative Numbers, Power Of Compound Interest, Rate Of Return, Raymond James, Sage Advice, Wit
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Pigs and Panics! (Saut)

Tuesday, April 10th, 2012

by Jef­frey Saut, Chief Invest­ment Strate­gist, Ray­mond James
April 9, 2012

“When prices of pork prod­ucts begin to rise, farm­ers nat­u­rally begin to increase the breed­ing of pigs, hop­ing to profit from the ris­ing mar­ket. Each farmer con­sid­ers him­self astute and novel in con­cept, quite cer­tain that prices will con­tinue to rise. How­ever, the same idea occurs to a large num­ber of farm­ers simul­ta­ne­ously. It takes about one and one-half years for a pig to reach matu­rity, and the same one and one-half years for the mar­ket to become sat­u­rated with the flood of recently bred pigs. Inevitably, prices fall, farm­ers sadly take losses and reluc­tantly cut back pro­duc­tion. Finally, as a result of the reduced breed­ing, short­ages develop and the cycle begins anew.”

... Panic & Crashes And How You Can Make Money Out Of Them; Harry Schultz 1972

Harry D. Schultz wrote a book at the top of the mas­sive sec­u­lar “pork mar­ket peak” of 1972 titled “Pan­ics & Crashes And How You Can Make Money Out Of Them.” He pointed out that busi­ness, and panic-to-pig cycles, fol­low pretty much the same pat­tern. The typ­i­cal cycle con­sists of seven phases: 1) short­ages, 2) the devel­op­ment of a con­cept, 3) prof­itable pro­duc­tion, 4) over­pro­duc­tion and over­sup­ply lead­ing to losses, 5) losses, 6) cut­backs in pro­duc­tion, 7) short­age and the start of a whole new cycle. Over the years Wall Street has also had a series of pig-to-panic cycles for those of us old enough to remem­ber them. The sequence went some­thing like this: bowl­ing alleys, color TVs, con­glom­er­ates, Alaskan oil stocks, dou­ble knits, air pol­lu­tion, CB radios, mobile phones, soft con­tact lenses, Wankel engines, one-decision growth stocks, gam­bling casi­nos, Inter­net insan­ity, eye­balls per minute val­u­a­tions, and most recently social media stocks. The les­son through­out the decades is that short­ages even­tu­ally lead to over­sup­ply. Last week that obser­va­tion came into plain view.

Indeed, last week the entire stuff-stock com­plex cratered. Recall, I have been bull­ish on “stuff” since China joined the WTO in Decem­ber 2001 on the premise that when per capita incomes rise peo­ple con­sume more “stuff” (oil, gas, coal, water, elec­tric­ity, tim­ber, cement, agri­cul­ture, base/precious-metals, etc.). That has been the his­tory of ris­ing per capita incomes through­out his­tory. We rode that theme until November/December 2007 when those invest­ments grew into such large posi­tions in port­fo­lios that we rec­om­mended sell­ing 30 – 50% of them to raise cash and allow long-term cap­i­tal gains to accrue to port­fo­lios as we entered 2008 very defen­sively posi­tioned. Fol­low­ing the March 2009 bot­tom­ing sequence, how­ever, stuff-stocks returned to promi­nence until April of 2011.

Since April of 2011 the Con­tin­u­ous Com­mod­ity Index (CCI/565.15) has been in decline hav­ing fallen from its high of ~691 into Decem­ber 2011’s tax-loss sell­ing “low” of ~546 as can be seen in the atten­dant chart. From there the CCI ral­lied into late Feb­ru­ary where it peaked and began sell­ing off. The sell­ing inten­si­fied last week seem­ingly due to the Fed­eral Reserve’s infer­ence that QE3 is effec­tively off of the table. With that, the U.S. dol­lar soared and the CCI plunged. That action caused one old mar­ket maven to exclaim, “Have com­modi­ties begun another ‘leg’ down, or was this just a pull­back within the con­text of a new upward trend?” My sense is it is the lat­ter, and I would invest that way using the Exchange Traded Prod­uct of your choice with last December’s “low” as a fail­safe point.

As for ideas in the com­mod­ity com­plex, a good start­ing point might be the com­modi­ties that per­formed best in 1Q12. To this point, the insight­ful Minyanville orga­ni­za­tion notes (as para­phrased by me):

“For those look­ing for the next cheap buy, or com­modi­ties that have been on a tear, we out­line some of the best and worst per­form­ing futures from the first quar­ter of this year: Soy­beans (+24%), Soy­bean Meal (+17%), Gaso­line RBOB (+21%), Canola Oil (+18%), Crude Brent Oil (+16%), and Plat­inum (+14%). And then there were the losers: Nat­ural Gas (-30%), Cof­fee (-18%), and Milk (‑9%).”

For spe­cific ways to play those select com­mod­ity themes, I sug­gest you con­tact our Exchange Traded Prod­ucts research department.

Like com­modi­ties, stocks swooned on the Fed’s state­ment; and, that swoon accel­er­ated on Wednes­day as par­tic­i­pants pon­dered a botched Span­ish debt auc­tion that showed decid­edly higher fund­ing costs for La Furia Roja (the red fury, aka Spain). The result left the S&P 500 (SPX/1398.08) lower by 10.39 points, but still above the first ledge of sup­port often ref­er­enced in these com­ments between 1375 and 1385. Inter­est­ingly, all of the pull­backs in the SPX this year have been between 25 and 35 points. Accord­ingly, mea­sur­ing from last Monday’s clos­ing reac­tion high of ~1419 pro­duces a level of 1394 for a 25 point cor­rec­tion, and 1384 for a 35 pointer. Impor­tantly, any­thing more than a 45 point pull­back would put the SPX below the bot­tom of our 1375 – 1385 sup­port zone — and sug­gest some­thing has changed. It would also rep­re­sent a break­down below a spread triple-bottom for most of the major aver­ages. While there is minor sup­port at 1365, my hunch is that break­ing below 1375 brings into view the 1320 – 1340 level.

This week should be the deci­sion point for the market’s near-term direc­tion­al­ity as this morn­ing stocks will have to deal with Friday’s dis­ap­point­ing employ­ment report. In last Monday’s let­ter I opined the employ­ment report was antic­i­pated to be dis­ap­point­ing; and, dis­ap­point­ing it was. Indeed, non-farm pay­rolls increased a very mod­est 120,000 for March ver­sus con­sen­sus esti­mates for a 205,000 gain. The report was exactly half of the pre­vi­ous month’s gain of 240,000 and well below the Decem­ber through Feb­ru­ary aver­age pay­rolls increase of 246,000. Our econ­o­mist, Dr. Scott Brown, had this to say about Friday’s report:

“Dis­ap­point­ing, but not a dis­as­ter. This is largely a weather story. Mild weather inflated pay­rolls fig­ures for Jan­u­ary and Feb­ru­ary and gen­er­ated exces­sive opti­mism about the job mar­ket. The weather was still mild in March, but Jan­u­ary and Feb­ru­ary were much milder than usual. The three-month aver­age pay­roll gain, at +210,000, is not bad. The unem­ploy­ment rate fell, but that was due to peo­ple exit­ing the labor force (likely as their unem­ploy­ment insur­ance ben­e­fits expire).”

So, this week should be the test for stocks. My sense is that fol­low­ing this morning’s jobs-induced drop, the SPX will remain mired in the 1385 – 1425 con­sol­i­da­tion zone I have been com­ment­ing on for the past few weeks. As stated, I think the SPX needs to con­va­lesce while the short-term over­bought con­di­tion is alle­vi­ated and the market’s inter­nal energy is rebuilt. As seen in the nearby chart, the over­bought con­di­tion has been cor­rected with the NYSE McClel­lan Oscil­la­tor back in over­sold ter­ri­tory (Energy and Mate­ri­als are the two most over­sold sec­tors). More­over, my daily inter­nal energy indi­ca­tor now has more than a full charge of energy. Unfor­tu­nately, the weekly inter­nal energy indi­ca­tor is nowhere near being fully recharged. The impli­ca­tion is that the down­side should be some­what con­tained, but the SPX is also not likely to break out above 1425 with­out spend­ing some more time consolidating.

The call for this week: As stated, this is a key week for the equity mar­kets and we con­tinue to wait and see how the equity mar­kets resolve them­selves on a short-term basis, a trad­ing stance we have been in for weeks. Mean­while, for investors, I met with a port­fo­lio man­ager last week whose invest­ment style I think is suited for the cur­rent stock mar­ket cli­mate. The invest­ment style of Troy Shaver, PM of Div­i­dend Asset Cap­i­tal, sub-advisor to Gold­man Sachs Ris­ing Div­i­dend Growth Fund (GSRAX/$15.05), is to invest in com­pa­nies that increase their div­i­dends by 10% per year on aver­age for 10 years in a row. Accord­ingly, the fund seeks cap­i­tal appre­ci­a­tion and cur­rent income. The other insight of the week was a con­fer­ence call on the Yorkville High Income MLP ETF (YMLP/$19.85). YMLP is struc­tured for an out­sized cur­rent yield by invest­ing in Mas­ter Lim­ited Part­ner­ships. Yet because of that struc­ture no tax-cumbersome K-1 is issued. For fur­ther infor­ma­tion please con­tact our Exchange Traded Prod­uct research department.

P.S. – I am trav­el­ing the bal­ance of this week, and while I will try to do at least one strat­egy call, it is going to be pretty dif­fi­cult to accom­plish given my sched­ule. Accord­ingly, this may be the only strat­egy com­ment for the week.

Click here to enlarge

Click here to enlarge

Tags: Air Pollution, Alaskan Oil, Bowling Alleys, Casinos Internet, Cb Radios, Chief Investment Strategist, Color Tvs, Growth Stocks, Harry D Schultz, Harry Schultz, Internet Insanity, jeffrey saut, Market Peak, Media Stocks, oil stocks, Pork Market, Pork Products, Profitable Production, Soft Contact Lenses, Typical Cycle
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Comfortably Numb: Have Investors Become Too Complacent?

Wednesday, April 4th, 2012

Com­fort­ably Numb: Have Investors Become Too Complacent?

April 2, 2012

Let's get right to the point: It was the best first quar­ter for the stock mar­ket since 1998. The total return of the S&P 500 index® was 12.6% for the quar­ter; up nearly 30% from the Octo­ber 3, 2011 low. What was par­tic­u­larly notable about the surge since then has been the atten­dant plunge in volatility.

Com­pla­cency?

As you can see in the chart below, the CBOE Volatil­ity Index (VIX) has dropped dra­mat­i­cally from its high of 48 last August (when Washington's fear­less lead­ers failed to con­struct a debt deal, lead­ing to Stan­dard & Poor's down­grade of US debt) to 15 recently.

Plung­ing Volatility

Source: Fact­Set, as of March 30, 2012.

Many investors—notably those painfully on the sidelines—have sug­gested this shows a high level of com­pla­cency. And the fact that trad­ing vol­ume has been weak has been another pil­lar in the bears' case for why the "rally isn't for real." (See more on trad­ing vol­ume later in this report.)

Most read­ers know I have been opti­mistic, and remain so. But, the con­trar­ian in me does have some sym­pa­thy for the case that opti­mism has become ele­vated enough to offer a head­wind for the mar­ket in the near term.

I am a big fan of the sen­ti­ment work done by Ned Davis Research (NDR) and SentimenTrader.com. NDR noted recently in a report that the recent backup in Trea­sury yields has accom­pa­nied a rise in opti­mism by investors, and this com­bined indi­ca­tor did flash a short-term sell sig­nal for the mar­ket. That said, NDR argues, and I con­cur, that yields remain extremely low and as such, are not "bit­ing" stocks yet.

Ele­vated opti­mism = near-term headwind

Below is NDR's most widely-followed sen­ti­ment mea­sure, its Crowd Sen­ti­ment Poll, and as you can see, accom­pa­ny­ing the market's rally has been a surge in opti­mism into the "uncom­fort­able" zone. Given a bit chop­pier action lately by stocks, I am hope­ful we will see a wan­ing of this opti­mism, at least back into the neu­tral zone.

Ele­vated Optimism

Source: Fact­Set, Ned Davis Research (NDR), Inc. (Fur­ther dis­tri­b­u­tion pro­hib­ited with­out prior per­mis­sion. Copy­right 2012 © Ned Davis Research, Inc. All rights reserved.), as of March 27, 2012.

Another sen­ti­ment met­ric show­ing ele­vated opti­mism is SentimenTrader's Smart Money/Dumb Money Con­fi­dence index, shown below.

Smart Money Warm­ing Up to Market

Source: Fact­Set, SentimenTrader.com, as of March 30, 2012.

Although no where near the recent extremes of smart money pes­simism and dumb money opti­mism, it bears watch­ing. The good news is that the gap has begun to nar­row in a favor­able way. Remem­ber, as the labels sug­gest, the smart money tends to be right at extremes of sen­ti­ment, while the dumb money tends to be wrong.

Crash wor­ries still abound

But not all sen­ti­ment met­rics are cre­ated equal. One I dis­cov­ered recently is put together by the folks at Yale and it mea­sures the per­cep­tions about the like­li­hood of a stock mar­ket crash among indi­vid­ual and insti­tu­tional investors. I quib­ble with the way they pose the ques­tion, mak­ing the chart a lit­tle dif­fi­cult to deci­pher, but let me explain. First, see the chart below:

Crash Like­li­hood Still Seen as High

Source: Fact­Set, Yale School of Management/International Cen­ter for Finance, as of Feb­ru­ary 28, 2012.

The ques­tion is asked in a way that the read­ing expresses the per­cent­age of sur­vey respon­dents that believe a crash will not occur. In other words, as per the lat­est read­ings, less than 25% of the survey's respon­dents, either indi­vid­ual or insti­tu­tional, believe the mar­ket won't suf­fer a crash. Put another way, more than 75% believe there's a high like­li­hood of a crash. This is a clear sign that the "wall of worry" the stock mar­ket likes to climb is still very much intact.

Investors lov­ing bonds

Much of what I've high­lighted above are sen­ti­ment mea­sures of atti­tudes, not actions. One clear way to judge the lat­ter is to look at mutual fund flows. Given that the past five years have seen a record $1.3 tril­lion spread in favor of bonds over stocks, I agree with the notion that investors have yet to become overly enthused by stocks.

All About Bonds

Source: Fact­Set, Invest­ment Com­pany Insti­tute, as of Feb­ru­ary 28, 2012.

I also think fund flows help explain why trad­ing vol­ume has been so low. Sim­ply, the retail investor has not been engaged with this mar­ket rally and much money has remained on the side­lines. Add to that the fact that high-frequency traders (HFT), which accounted for over 70% of last year's trad­ing vol­ume at times, are under a mag­ni­fy­ing glass held by the Secu­ri­ties and Exchange Com­mis­sion (SEC) for ques­tion­able trad­ing prac­tices. This has likely kept many of the HFTs in hibernation.

Busi­nesses happy; con­sumers less so

Let me step off the mar­ket path for a moment and share another inter­est­ing sen­ti­ment analy­sis. Last Wednes­day, the Busi­ness Round­table recently released its first quar­ter CEO Eco­nomic Out­look Sur­vey, pre­ceded the day before by the release of the Con­fer­ence Board's mea­sure of con­sumer con­fi­dence. CEOs are now as opti­mistic as they were dur­ing much of the pre-recession period. Although they cite head­winds includ­ing Europe, China, oil prices and US polit­i­cal uncer­tainty, they do not believe they will mate­ri­ally impact their business.

On the other hand, con­sumer con­fi­dence pulled back from a still-weak read­ing in the lat­est report. It had risen sharply in Feb­ru­ary. The level of con­fi­dence, with a head­line of 70, is well below where the index stood dur­ing prior eco­nomic expansions.

For what it's worth, CEO con­fi­dence has his­tor­i­cally acted in a sim­i­lar man­ner as the afore­men­tioned "smart money" and its high level of con­fi­dence is com­fort­ing. On the other hand, very weak peri­ods of con­sumer con­fi­dence have typ­i­cally been accom­pa­nied by higher stock mar­ket gains, as the con­sumer has his­tor­i­cally acted in a sim­i­lar man­ner as the afore­men­tioned "dumb money."

Schwab's sur­vey says

Finally, we have a new sur­vey from Schwab of its active traders. The lat­est Charles Schwab Active Trader Sen­ti­ment Sur­vey polled 421 indi­vid­ual investors who trade fre­quently and found 51% now con­sider them­selves bullish—the high­est level since we began track­ing active trader sen­ti­ment in April 2008. This is up from only 25% in Octo­ber 2011. Only 14% say they are cur­rently bearish.

In sum, my opti­mism in the medium-to-long-term has not been dented by the lat­est sen­ti­ment read­ings. Last week was the 26th con­sec­u­tive week of better-than-expected eco­nomic news. Of the 17 indi­ca­tors that ISI tracks that did a good job track­ing 2010 and 2011 double-dip reces­sion con­cerns, only two are presently weak­en­ing, with First Call's earn­ings revi­sion index notably strong. How­ever, I do think the mar­ket has become more vul­ner­a­ble to neg­a­tive news in the short term.

Impor­tant Disclosures

Tags: Cboe Volatility Index, Charles Schwab, Chief Investment Strategist, China, Complacency, Contrarian Indicator, Debt Deal, Factset, Fearless Leaders, Headwind, Liz Ann, Ndr, Ned Davis Research, Optimism, Plunge, Senior Vice President, Sentimentrader, Sidelines, Stock Market, Treasury Yields, Volatility Index Vix
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“Shrugging Off Bad News!” (Saut)

Tuesday, April 3rd, 2012

“Shrug­ging Off Bad News!”

by Jef­frey Saut, Chief Invest­ment Strate­gist, Ray­mond James

April 2, 2012

Most traders, and investors, seem to become con­vinced of the gen­uine­ness of a move­ment in either direc­tion only when it approaches a cul­mi­na­tion. . . . One reli­able indi­ca­tion of the start of an upward swing is afforded when, after a period of declin­ing prices or, less fre­quently, dull­ness, the mar­ket advances or refuses to go down fol­low­ing the receipt of bad news. News can sel­dom be uti­lized by the pub­lic for mar­ket pur­poses, even when its authen­tic­ity is beyond ques­tion. For instance, if tomor­row morning’s news­pa­pers should announce the death of the Pres­i­dent or the fail­ure of a great ‘cor­ner house,’ or the com­plete destruc­tion of Gary, Indi­ana, it is more likely that stocks sold on the news would bring the low­est prices of the day, for the very good rea­son that each seller would be com­pet­ing with thou­sands of other sell­ers who would have learned the news at the same time.

... One-Way Pock­ets, by Don Guyon; 1917

One of my early men­tors in this busi­ness was Lucien Hooper; strate­gist, ana­lyst, econ­o­mist, stock mar­ket his­to­rian, the longest con­tribut­ing colum­nist to Forbes, and my friend. I can hear his sage words like it was yes­ter­day. The year was 1971, and we had just walked across the floor of the Amer­i­can Stock Exchange. As we headed down the atten­dant stair­case for lunch at “Harry at the Amex” Lucien said, “Jef­frey, when mar­kets ignore bad news, that’s good news!” Said state­ment has stuck with me ever since; and, it is just as true today as it was 41 years ago. Fast for­ward, over the past few weeks the equity mar­kets have had to endure a plethora of bad news – China’s slow­ing econ­omy, ris­ing inter­est rates, $4.00 per gal­lon gaso­line, a dys­func­tional gov­ern­ment, Iran, etc., yet the equity mar­kets have refused to sur­ren­der much ground. Last week was no excep­tion, for despite the neg­a­tive news back­drop the senior index (INDU/13212.04) gained 1%. Such action remains con­sis­tent with my mantra for this year, “You can get cau­tious, but DO NOT get bear­ish.” How­ever, many investors are either bear­ish, or frozen like a deer in the head­lights of a car, hav­ing been stung in last year’s June – August angst because they didn’t man­age the risk when they should have.

Recall, it was in March/April of last year that I rec­om­mended rais­ing cash. At the time the major “push back” from accounts was, “The stock mar­ket is going up, why should I raise cash?” And that was the exact rea­son you should have been rais­ing cash and rebal­anc­ing port­fo­lios. Most did not heed that strat­egy and sub­se­quently suf­fered through a ~20% decline only to liq­ui­date their port­fo­lios around August 8th when the equity mar­kets were in the process of bot­tom­ing. At the time I was actu­ally rec­om­mend­ing putting cash back to work based on the fact that we were expe­ri­enc­ing a cli­mac­tic capit­u­la­tion of his­toric pro­por­tions. Indeed, at the August 8th “low” less than 2% of all stocks traded were “up” on the day. As writ­ten, “You have to go back to May 13, 1940 to find another ses­sion whereby less than 2% of all stocks traded were ‘green’ on the day. Inter­est­ingly, on 5/13/40 the Ger­man army punched a 60-mile wide hole in the Mag­inot Line and invaded France, leav­ing every­one think­ing, “It’s the end of the world as we know it!”

Luck­ily, at those August lows, I began using the anal­ogy of the declines that occurred in Octo­ber 1978 and Octo­ber 1979 (see the charts on page 3). Those late-1970s Octo­ber declines came out of the blue, and were equally as debil­i­tat­ing as the June – August 2011 affair. They also ended with a sell­ing cli­max like that seen on August 8, 2011. As writ­ten at the time, post the selling-climax the sub­se­quent trad­ing pat­terns of Octo­ber 1978 and 1979 saw a bot­tom­ing sequence that left the senior index bob­bing and weav­ing for seven to eight weeks fol­lowed by an “under­cut low” (a low below the selling-climax low) that was for buy­ing. Study­ing the atten­dant charts shows the cor­re­la­tion between the Octo­ber 1978 and 1979 bot­tom­ing sequences and last year’s bot­tom­ing sequence, which is what gave me the con­vic­tion to rec­om­mend buy­ing the Octo­ber 4, 2011 “under­cut low.” Since then, I have been pretty bull­ish, save my cau­tion of the past num­ber of weeks. Indeed, for the past month I have averred that the over­bought con­di­tion of the indices could be cor­rected in one of two ways. They could either cor­rect with the per­func­tory 5–8% pull­back, or they could trade side­ways while the stock market’s over­bought con­di­tion was cor­rected, and the market’s inter­nal energy was rebuilt. Obvi­ously, at least so far, it has been a side­ways affair, which brings us to the start of the new quarter.

So, what’s in store going for­ward? I believe the Fed­eral Reserve wants Wall Street to inflate; and, with the Pres­i­den­tial elec­tions loom­ing, Pres­i­dent Obama will likely do every­thing in his power to keep the stock mar­ket ebul­lient. Thus, investors should be pre­pared for fur­ther poli­cies designed to stim­u­late the econ­omy, which should allow stocks to travel higher even if they do pause, or stum­ble, in the near-term on con­cerns the fun­da­men­tals are turn­ing squir­relly. Nev­er­the­less, what many investors don’t under­stand is that in the short/intermediate-term there is not a lin­ear rela­tion­ship between the fun­da­men­tals and the stock market’s direc­tion­al­ity. Man­i­festly, it is the dilu­tion of our cur­rency, with a con­cur­rent decline in its value due to a mas­sive increase in the money sup­ply, which is caus­ing money to flow into assets of all kinds, includ­ing stocks. And that, ladies and gen­tle­men, is the nat­ural reac­tion to the flood of liq­uid­ity injected into the sys­tem by the world’s cen­tral banks. I don’t think it will end any­time soon.

Mean­while, the over­bought con­di­tion, as reflected by the NYSE McClel­lan Oscil­la­tor, that got us wor­ried fol­low­ing the end of the “buy­ing stam­pede” at the end of Jan­u­ary, has been cor­rected; and the stock market’s inter­nal energy is being rebuilt. Ver­ily, our daily inter­nal energy indi­ca­tor has lifted from a “totally used up” 30 read­ing on March 19th to 50 as of last Fri­day. For a full charge of energy that indi­ca­tor needs to be above 55. The weekly energy indi­ca­tor, how­ever, is still around the 30 level. Hereto, for a full charge of energy the weekly needs to be above 55. Accord­ingly, my sense is that the equity mar­kets need another few weeks of con­va­lesc­ing, prob­a­bly in a range between 1385 and 1420 basis the S&P 500 (SPX/1408.47), before they are ready to re-rally. The big test for this week should be Friday’s employ­ment report, which is antic­i­pated to be bad. Still, as long as the SPX resides above 1385 the bull­ish case remains intact.

Speak­ing to the econ­omy, while last week’s +3% GDP report was in the fore­front, less noticed was the GDI report. Sur­pris­ingly, the Gross Domes­tic Income report rose a larger than expected 4.4%. This is not an unim­por­tant obser­va­tion because the GDI mea­sures all the wages and prof­its in the econ­omy while the GDP mea­sures only spend­ing. The­o­ret­i­cally, the GDP and GDI reports should be the same. To me, this is just fur­ther evi­dence that the econ­omy is not sink­ing back into reces­sion. Another boost for the equity mar­kets last week seemed to be the tone of the ques­tion­ing by the Supremes sug­gest­ing Oba­macare may be in more trou­ble than expected. Such news con­tin­ues to be a night­mare for the under­in­vested crowd; and the world remains pro­foundly under­in­vested in U.S. equities.

The call for this week: March came in like a bear, but went out like a bull, cap­ping the best first quar­ter since 1998. For the quar­ter the SPX gained 11.99% for its 10th best start of the year ever. For me it was almost like déjà vu as I recalled the best first quar­ter of my life­time, which was 1975’s surge of 21.59%. Why déjà vu? Well, it is because I began writ­ing strat­egy In Novem­ber of 1974 with the line, “I believe now is the time to accu­mu­late stocks.” At the time the Dow was trad­ing below 600, hav­ing fallen from its March high of 891 for a 34% decline. Sim­i­larly, on Octo­ber 3, 2011, in a report titled ”Under­cut Low” I rec­om­mended buy­ing stocks fol­low­ing the Dow’s decline of ~20%. As stated at the time, “I have been adamant since March 2009 that like the ‘nom­i­nal’ price low of Decem­ber 1974 this wide-swinging trad­ing range mar­ket saw its nom­i­nal price in March 2009. Last Octo­ber I sug­gested what we could cur­rently be expe­ri­enc­ing is sim­i­lar to the “val­u­a­tion” low of August 1982 because the SPX was trad­ing below 10x for­ward earn­ings esti­mates with an earn­ings yield of over 10%, ren­der­ing an equity risk pre­mium of more than 8% for val­u­a­tion met­rics not seen in decades. I still believe that is the case.

Click here to enlarge

Copy­right © Ray­mond James

Tags: American Stock Exchange, Amex, Bad News, Chief Investment Strategist, China, Culmination, Don Guyon, Gary Indiana, Genuineness, Hooper, India, jeffrey saut, Lucien, Negative News, One Way Pockets, Plethora, Raymond James, Rising Interest Rates, Sage Words, Stock Market, Time One, Upward Swing
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Shifting Winds-Turbulence Ahead? (Sonders)

Monday, April 2nd, 2012

Shift­ing Winds-Turbulence Ahead?

March 30, 2012

by Liz Ann Son­ders,Senior Vice Pres­i­dent, Chief Invest­ment Strate­gist, Charles Schwab & Co., Inc., and,
Brad Sorensen, CFA, Direc­tor of Mar­ket and Sec­tor Analy­sis, Schwab Cen­ter for Finan­cial Research, and
Michelle Gib­ley, CFA, Direc­tor of Inter­na­tional Research, Schwab Cen­ter for Finan­cial Research

Key Points

• Trea­sury yields have moved some­what higher, while stocks have largely con­tin­ued to rise. Some recent cor­re­la­tions appear to be break­ing down, which could lead to some increased volatil­ity but we remain rel­a­tively con­fi­dent in the equity mar­ket. Per­cep­tion as to the next poten­tial moves by the Fed­eral Reserve appeared to be shift­ing, but Chair­man Bernanke reit­er­ated their easy mon­e­tary stance. Uncer­tainty is ris­ing and the Fed’s goal of increased clar­ity through more trans­par­ent com­mu­ni­ca­tion is under increased scrutiny.
• Liq­uid­ity con­cerns in Europe have eased but eco­nomic risks remain ele­vated, while Spain and Italy face deal with their ongo­ing debt crises. Mean­while, fears remain about a hard land­ing in China, although we have a more san­guine view.

Are we start­ing the return to a more "nor­mal" mar­ket envi­ron­ment? It's too early to tell but we are begin­ning to see lower volatil­ity and asset class cor­re­la­tions. Con­tribut­ing to this more sta­ble envi­ron­ment is a shift­ing of Fed expec­ta­tions and increased investor con­fi­dence about US eco­nomic expan­sion. How­ever, we acknowl­edge that such a shift will likely cause some near-term tur­bu­lence in the mar­ket, espe­cially given ele­vated bull­ish investor sen­ti­ment (a con­trar­ian indi­ca­tor). The mar­ket has also become tech­ni­cally extended after its roughly 30% rally since early Octo­ber 2011, and could be due for a breather. Addi­tion­ally, an uncer­tain earn­ings sea­son is approach­ing, oil prices con­tinue to be con­cern­ing, and the siren song of "sell in May" is likely to be heard again. We believe any con­sol­i­da­tion is likely to be shal­low and could bring back some of the "wall of worry" that the mar­ket loves to climb.

One of this year’s ear­lier trends had been stocks mov­ing higher, but Trea­sury bond yields remain­ing near record lows, indi­cat­ing both con­tin­ued con­cern about the sus­tain­abil­ity of the eco­nomic expan­sion, and the con­fi­dence that the Fed­eral Reserve would con­tinue its extremely accom­moda­tive mon­e­tary stance for the fore­see­able future. Recently, we’ve seen Trea­sury yields move up from those record lows, while stocks con­tin­ued to move higher. This could be the begin­ning of a shift in investor atti­tudes as con­fi­dence in the eco­nomic expan­sion may be grow­ing lead­ing to skep­ti­cism that the Fed can main­tain its cur­rent pol­icy stance through 2014.

Yields Move Higher—For Pos­i­tive Reasons

Source: Fact­Set, Fed­eral Reserve. As of Mar. 27, 2012.

While it's too early to say this is the start of a trend of yields mov­ing inex­orably higher, it does appear that the retail investor could begin to shift some assets from bond funds and cash into equi­ties. This could feed the next leg up in the equity rally.

Eco­nomic Transition

Part of the impe­tus behind the retail investor warm­ing up to equi­ties may be the improve­ment in eco­nomic data—especially as it relates to jobs and hous­ing. But here too we may be enter­ing a tran­si­tion phase as year-over-year com­par­isons become more dif­fi­cult and sub­stan­tial gains become harder to come by. Hous­ing data con­tin­ues to be mixed and although ini­tial job­less claims recently hit their low­est level in three years, the pace of the recov­ery in jobs could slow. This could con­tribute to near-term volatil­ity, but we do believe in the sus­tain­abil­ity of the eco­nomic expan­sion, which should help to sup­port equity prices through the bal­ance of 2012.

Jobs pic­ture con­tin­ues to improve

Source: Fact­Set, U.S. Dept. of Labor. As of Mar. 27, 2012.

Hous­ing is not off to the races and likely won’t see a sharp bounce off of the bot­tom, but we are see­ing encour­ag­ing signs. Although exist­ing home sales fell 0.9% month-over-month in Feb­ru­ary, it was still the best Feb­ru­ary read­ing in five years and sales were up 8.8% over a year ago. Mean­while, hous­ing starts fell 1.1% but forward-looking build­ing per­mits rose 5.1%, to the high­est level since Octo­ber 2008. And while hous­ing remains extremely afford­able based on his­tor­i­cal lev­els, mort­gage rates have moved mod­estly higher. Some­what counter-intuitively this could con­tribute to fur­ther improve­ment of the hous­ing mar­ket as the prospect of rates actu­ally mov­ing higher may push poten­tial pur­chasers who had been sit­ting on the fence toward action.

Other eco­nomic data con­tin­ues to show growth in the econ­omy, although there are some poten­tial chinks that we are watch­ing closely. The Empire Man­u­fac­tur­ing Index moved to its high­est level since June 2010 while the Philly Fed Index rose to its best read­ing since April 2011. How­ever, the for­ward look­ing new orders com­po­nent of both reports moved lower. While not overly con­cern­ing yet, it’s some­thing we’re keep­ing an eye on.

Addi­tion­ally, the Index of Lead­ing Eco­nomic Indi­ca­tors rose 0.7% in Feb­ru­ary, mark­ing the fifth-straight month of improve­ment. The National Fed­er­a­tion of Inde­pen­dent Busi­nesses Index moved higher, indi­cat­ing improv­ing small busi­ness con­fi­dence. Finally, retail sales moved 1.1% higher; while ex-autos and gas they moved 0.6% higher and the pre­vi­ous month was also revised upward, indi­cat­ing the Amer­i­can con­sumer con­tin­ues to spur activity.

Fed Stance Shifting?

This con­tin­ued improv­ing data may be con­tribut­ing to a shift in the per­cep­tion of the future of Fed pol­icy. While the recent Fed meet­ing kept pol­icy the same and con­tin­ued to pre­dict near zero inter­est rates through at least late 2014, they did upgrade their out­look of the econ­omy slightly. Also, sev­eral Fed mem­bers have said they believe higher inter­est rates may be needed sooner than cur­rently offi­cially pre­dicted. The fed funds futures mar­ket has the first rate hike com­ing at least six months before the end of 2014. And finally, dur­ing Chair­man Bernanke’s recent tes­ti­mony on Capi­tol Hill, he did noth­ing to indi­cate another round of quan­ti­ta­tive eas­ing was in the cards, lead­ing investors to believe the Fed's con­fi­dence in the eco­nomic expan­sion may be grow­ing. How­ever, in a sub­se­quent speech, he reit­er­ated his belief that the econ­omy and job mar­ket would con­tinue to need Fed assis­tance, throw­ing a lit­tle more uncer­tainty into the equa­tion. We are encour­aged at these glim­mers of hope and believe that a return to more nor­mal pol­icy sooner rather than later would be appropriate.

Europe’s debt cri­sis merely on pause

The sec­ond Greek bailout was com­pleted on March 20 with mar­kets hardly bat­ting an eye. But the euro­zone sov­er­eign debt cri­sis is far from over—it is merely on pause and there is still risk of future outbreaks.

Where could sov­er­eign debt con­cerns arise?

• Greece and Por­tu­gal could need addi­tional bailouts;
• Ire­land could ask for debt for­give­ness to bol­ster a pub­lic vote for the fis­cal pact;
• France’s gen­eral elec­tion could result in a change of lead­er­ship from Sarkozy to Hollande.

How­ever, we feel these poten­tial events are unlikely to result in a broad con­ta­gion out­break. On the other hand, Spain and Italy have the abil­ity to heat up con­cerns and risk aver­sion due to their large debts and economies. Italy’s econ­omy has grown less than the euro­zone aver­age over the past decade and reforms are needed to improve com­pet­i­tive­ness and enhance growth prospects. Ital­ian Prime Min­is­ter Monti needs to keep mak­ing progress to main­tain investor con­fi­dence, and watered down labor reforms may not have a last­ing effect.

How­ever, Italy has some pos­i­tive attrib­utes, includ­ing a wealthy pri­vate sec­tor with a per capita net worth more than three times higher than the other Euro­pean periph­eral coun­tries, accord­ing to BCA Research, giv­ing them the abil­ity to fund debt locally. As such, Italy’s debt tends to be in stronger, longer-term, hands. Addi­tion­ally, Italy has a pri­mary bud­get sur­plus – a sur­plus before debt pay­ments – as well as long debt maturities.

Spain's hous­ing bub­ble still deflating

Source: Fact­Set, S&P/Case-Shiller, Bank of Spain. As Mar. 27, 2012. Indexed to 100 = 1/1/1996.

Spain on the other hand has a more uncer­tain and risky out­look. While Spain’s cur­rent gov­ern­ment debt load is smaller than Italy’s as a per­cent­age of gross domes­tic prod­uct (GDP), it has an ele­vated deficit, high and ris­ing unem­ploy­ment and a hous­ing bub­ble that is still deflat­ing. A risk is that the large amount of pri­vate sec­tor debt could incur more losses for banks, poten­tially requir­ing cash infu­sions from the gov­ern­ment. Addi­tion­ally, instead of mak­ing deficit-reduction progress, Spain has backpedaled; now tar­get­ing a higher deficit to end 2012 than envi­sioned a few months ago.

Pos­i­tively, Euro­pean pol­i­cy­mak­ers are doing their part to con­tain risks, from the Euro­pean Cen­tral Bank's three-year loans and Germany's recent will­ing­ness to com­bine the tem­po­rary Euro­pean Finan­cial Sta­bil­ity Facil­ity (EFSF) with the longer-term Euro­pean Sta­bil­ity Mech­a­nism (ESM) that comes into effect in July. How­ever, an even big­ger fire­wall may even­tu­ally be needed.

Europe drag­ging down global growth

The lin­ger­ing effects of the sov­er­eign debt cri­sis on the Euro­pean econ­omy con­tinue. The renewed down­turn of euro­zone pur­chas­ing man­ager indexes in March indi­cate the econ­omy is still frag­ile and it could take some time before growth reac­cel­er­ates. A hob­bled Euro­pean bank­ing sys­tem remains at the heart of the slow­down. Bank bal­ance sheets likely don't have enough excess cap­i­tal to expand lend­ing and banks have responded by tight­en­ing lend­ing stan­dards. Lend­ing is the lifeblood of eco­nomic growth and a severe reduc­tion in lend­ing is likely to restrain activity.

In terms of invest­ment impli­ca­tions, the out­look for Euro­pean stocks is mixed. Val­u­a­tions appear attrac­tive and we believe cor­re­la­tions will decline and investors will dif­fer­en­ti­ate across mar­kets. Mar­kets with stronger economies such as Ger­many could do bet­ter, while those with weaker eco­nomic out­looks, like Spain, could lag. The Ital­ian stock mar­ket falls in the mid­dle, as a neg­a­tive eco­nomic out­look is off­set by high pri­vate sec­tor wealth.

Should we worry about China?

There are plenty of bear­ish sto­ries about China these days and China remains a puz­zle to many. The lack of trans­parency and the view that news is fil­tered and man­aged helps fuel the fears.

We believe the truth lies some­where between the bear­ish and bull­ish case. We still believe that a hard land­ing is unlikely and that mar­kets are at times over-reacting to data that is really not new news. Exam­ples include the 7.5% growth tar­get for 2012 when the Five-Year Plan issued a year ago envi­sioned a 7% rate over the full period; and com­ments from BHP Bil­li­ton that demand for iron ore would drop to single-digits, which was not sig­nif­i­cantly dif­fer­ent than what they had said in the past.

Even reports that China's man­u­fac­tur­ing pur­chas­ing man­ager index (PMI) is in con­trac­tion ter­ri­tory are a mis­nomer. The PMI sur­vey is a dif­fu­sion index—a read­ing below 50 indi­cates more peo­ple say things are slower ver­sus last month than faster—in other words, below aver­age activ­ity. In a fast grow­ing econ­omy such as China, this does not nec­es­sar­ily equate to a contraction.

Man­u­fac­tur­ing in China slowing

Source: Fact­Set, Markit. As Mar. 27, 2012.

We have believed for some time that China's econ­omy would con­tinue to slow, but that a sharp drop in infla­tion and money sup­ply would allow stim­u­lus to be enacted that could reac­cel­er­ate growth later in 2012. How­ever, we are dis­cour­aged by so far mod­est pol­icy eas­ing amid signs of accel­er­ated slowing.

In par­tic­u­lar, the report that prof­its for Chi­nese indus­trial com­pa­nies fell 5.2% dur­ing the first two months of 2012 was worse than we expected. Granted, this fig­ure was after prof­its gained 34.3% a year ear­lier and is dur­ing a sea­son­ally weak period, so it may not be a last­ing trend, but is concerning.

The Chi­nese gov­ern­ment typ­i­cally takes grad­ual moves, but the slow pace of response while eco­nomic data is mov­ing faster indi­cates the gov­ern­ment could slip behind the eco­nomic momen­tum, then strug­gle to gain ground. China’s econ­omy is now the second-largest glob­ally and is becom­ing tougher to micro-manage – the risk of a pol­icy mis­take is grow­ing. We’re not ready to change our view as we believe we’re still in the early innings of the slow­down, but have a wary eye on pol­icy response.

An event that could have longer-term impli­ca­tions is the com­ing polit­i­cal changeover at year's end. Con­cerns have arisen after the party chief in Chongqing, one of China's biggest cities, was sacked in March. This is the high­est level offi­cial removed in over two decades. There appears to be increas­ing strains within the Com­mu­nist party about whether to move toward reforms or tighten con­trol. We'll be mon­i­tor­ing this over the com­ing year.

Read more inter­na­tional research at www.schwab.com/oninternational.

Impor­tant Disclosures

The MSCI EAFE® Index (Europe, Aus­trala­sia, Far East) is a free float-adjusted mar­ket cap­i­tal­iza­tion index that is designed to mea­sure devel­oped mar­ket equity per­for­mance, exclud­ing the United States and Canada. As of May 27, 2010, the MSCI EAFE Index con­sisted of the fol­low­ing 22 devel­oped mar­ket coun­try indexes: Aus­tralia, Aus­tria, Bel­gium, Den­mark, Fin­land, France, Ger­many, Greece, Hong Kong, Ire­land, Israel, Italy, Japan, the Nether­lands, New Zealand, Nor­way, Por­tu­gal, Sin­ga­pore, Spain, Swe­den, Switzer­land and the United Kingdom.The MSCI Emerg­ing Mar­kets IndexSM is a free float-adjusted mar­ket cap­i­tal­iza­tion index that is designed to mea­sure equity mar­ket per­for­mance in the global emerg­ing mar­kets. As of May 27, 2010, the MSCI Emerg­ing Mar­kets Index con­sisted of the fol­low­ing 21 emerging-market coun­try indexes: Brazil, Chile, China, Colom­bia, the Czech Repub­lic, Egypt, Hun­gary, India, Indone­sia, Korea, Malaysia, Mex­ico, Morocco, Peru, Philip­pines, Poland, Rus­sia, South Africa, Tai­wan, Thai­land and Turkey.The S&P 500® index is an index of widely traded stocks.Indexes are unman­aged, do not incur fees or expenses and can­not be invested in directly.Past per­for­mance is no guar­an­tee of future results.Investing in sec­tors may involve a greater degree of risk than invest­ments with broader diversification.International invest­ments are sub­ject to addi­tional risks such as cur­rency fluc­tu­a­tions, polit­i­cal insta­bil­ity and the poten­tial for illiq­uid mar­kets. Invest­ing in emerg­ing mar­kets can accen­tu­ate these risks.The infor­ma­tion con­tained herein is obtained from sources believed to be reli­able, but its accu­racy or com­plete­ness is not guar­an­teed. This report is for infor­ma­tional pur­poses only and is not a solic­i­ta­tion or a rec­om­men­da­tion that any par­tic­u­lar investor should pur­chase or sell any par­tic­u­lar secu­rity. Schwab does not assess the suit­abil­ity or the poten­tial value of any par­tic­u­lar invest­ment. All expres­sions of opin­ions are sub­ject to change with­out notice. The Schwab Cen­ter for Finan­cial Research is a divi­sion of Charles Schwab & Co., Inc.

Tags: asset class, Bernanke, Brazil, Canadian Market, Charles Schwab, Chief Investment Strategist, China, Contrarian Indicator, Earnings Season, Economic Expansion, Economic Risks, India, Investor Confidence, Investor Sentiment, Liz Ann, Market Environment, Market Perception, Monetary Stance, Russia, Sanguine View, Senior Vice President, Siren Song, Stable Environment, Transparent Communication, Treasury Yields
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James Paulsen: Does Gold Still Glitter?

Friday, March 30th, 2012

Does GOLD Still Glitter?

by James Paulsen, Chief Invest­ment Strate­gist, Wells Cap­i­tal Man­age­ment (Wells Fargo)

Gold has been an invest­ment dar­ling in recent years. Indeed, it is often per­ceived as the cure for any invest­ment worry. Whether you are con­cerned about infla­tion, defla­tion, gov­ern­ment deficits, war, a U.S. dol­lar col­lapse, reces­sion, or depression—GOLD is the answer!

The extra­or­di­nary pop­u­lar­ity of gold today is easy to understand—it has done so well for so long! Since the end of the 1990s, the price of gold has risen almost six-fold from less than $300 to its cur­rent price of almost $1,700. Many expect the price of gold to rise con­sid­er­ably higher in the next sev­eral years and per­ceive the mod­est decline in the gold price since its all-time peak last Sep­tem­ber as a buy­ing oppor­tu­nity. While own­ing some gold is fine for all investors (diver­si­fi­ca­tion is para­mount), we think gold weight­ings should be scaled back in most port­fo­lios. The yel­low metal may soon lose some of its lus­ter as its strug­gles with its newly ele­vated val­u­a­tion and with the like­li­hood that con­fi­dence through­out the econ­omy is begin­ning to improve.

Gold is OVERVALUED!

Unlike stocks or bonds, gold has always been more dif­fi­cult to value since it pro­duces no cash flow (i.e., earn­ings or coupons) that can be dis­counted to arrive at a present (fair) value. How­ever, Exhibit 1 illus­trates a sim­ple “rel­a­tive val­u­a­tion” method­ol­ogy pro­vid­ing an his­tor­i­cal per­spec­tive against most other invest­ment classes (e.g., stocks, bonds, com­modi­ties, and real estate) and rel­a­tive to the value of labor and a bas­ket of con­sumer goods and ser­vices. In each of the six charts shown, the price of gold on a rel­a­tive basis is either near­ing or is at one of its high­est val­u­a­tions of the last 50 years. At the end of the 1990s, it took almost 5.5 ounces of gold to buy the S&P 500 Stock Price Index. Today, it only takes 0.8 of a sin­gle ounce to buy the stock mar­ket. Rel­a­tive to stocks, gold is almost as expen­sive today as it was in the late 1970s when the price of gold had surged after its peg was elim­i­nated and after the stock mar­ket was rav­ished by a decade of run­away inflation.

Rel­a­tive to Trea­sury bonds, the price of gold cur­rently trades near an all-time, post-war record high sur­pass­ing its old rel­a­tive val­u­a­tion record estab­lished in the late 1980s when bonds were incred­i­bly cheap. It is indeed remark­able that gold today is this expen­sive rel­a­tive to an asset class (bonds) which most agree is prob­a­bly itself extremely overvalued.

In recent years, while gold prices have soared, U.S. home prices have col­lapsed. Although the price of gold rel­a­tive to U.S. homes is not yet as high as it reached in the late 1970s, its cur­rent rel­a­tive val­u­a­tion com­pared to house prices leaves lit­tle opti­mism about the future poten­tial for gold prices. Gold is also expen­sive rel­a­tive to worker pay. In 2000, it took less than 20 hours of work (at the aver­age hourly wage rate) to pur­chase a sin­gle ounce of gold. Today, by con­trast, it takes almost 90 hours of labor to buy an ounce of gold! In a sim­i­lar fash­ion, the price of gold rel­a­tive to the bas­ket of con­sumer goods and ser­vices com­pris­ing the Con­sumer Price Index is near its all-time record high reached in the early 1980s.

Finally, even com­pared to other com­mod­ity prices, the price of gold is near­ing its all-time record rel­a­tive price reached in the late 1980s. Even though com­mod­ity prices in gen­eral have increased sig­nif­i­cantly in the last decade, the price of gold has risen even more dramatically.

While val­u­a­tion met­rics have not tra­di­tion­ally been a good invest­ment tim­ing tool, they have pro­vided a use­ful indi­ca­tion of the future upside/downside price poten­tial of an invest­ment. Rel­a­tive to other invest­ments, the charts in Exhibit 1 not only sug­gest upside is prob­a­bly lim­ited for gold but also cau­tions that down­side price risk could be sig­nif­i­cant. At a min­i­mum, these charts do not seem to sup­port the wide­spread pop­u­lar­ity and opti­mism con­cern­ing gold investing.

Gold and the “Fear Premium”?

Exhibit 2 shows the price of gold rel­a­tive to other com­mod­ity prices. Although gold has been a spec­tac­u­lar invest­ment since 2000, so have other com­modi­ties. Sur­pris­ingly, since 2000, the price of gold has only sig­nif­i­cantly out­paced other com­mod­ity prices dur­ing a few months in late 2008 when the “Great Finan­cial Cri­sis” erupted. Between 2000 and late 2008, the rel­a­tive price of gold to other com­modi­ties remained flat at about 1.5 imply­ing both gold prices and other com­mod­ity prices rose by equal amounts dur­ing the period. Sim­i­larly, the rel­a­tive price of gold was also unchanged between early 2009 and today. That is, “all” com­mod­ity prices rose just as much as gold prices between 2000 and late 2008 and again between early 2009 until today (despite this, how­ever, gen­eral com­modi­ties remain a much less pop­u­lar invest­ment than gold).

The only time gold sig­nif­i­cantly out­paced other com­mod­ity invest­ments was when investor “fear” surged. Exhibit 2 illus­trates the “fear pre­mium” the price of gold received rel­a­tive to other com­mod­ity prices dur­ing the 2008 cri­sis and how much of this pre­mium is still embed­ded in its price today. Between 2000 and late 2008, the price of gold oscil­lated in broad range about 1.4 times the value of the S&P GSCI Com­mod­ity Price Index. Today, gold trades at about 2.4 times the value of this com­mod­ity index. The risk or fear pre­mium embed­ded in the price of gold (i.e., about 1.0, the dif­fer­ence between the rel­a­tive price of gold today at 2.4 and where it used to trade prior to the 2008 cri­sis at about 1.4) is quite large and needs to be assessed when con­sid­er­ing an invest­ment in gold. A pri­mary risk for gold investors is the poten­tial for decay in this fear premium.

Gold’s Best Friend (Fear) May be Fading?!?

Exhibit 3 illus­trates the chal­lenge gold investors may face in the next few years should con­fi­dence slowly improve and “cri­sis fears” fade. This exhibit com­pares the rel­a­tive price of gold to the Con­sumer Con­fi­dence Index. The con­fi­dence index (dot­ted line) is shown on an inverted scale so a rise (fall) in the dot­ted line illus­trates peri­ods when con­fi­dence is declin­ing (increasing).

While not a per­fect rela­tion­ship, the rel­a­tive price of gold rel­a­tive to other com­mod­ity prices seems impor­tantly dri­ven by con­fi­dence. Gold’s best friend in recent years has been fear! As con­fi­dence col­lapsed in 2008, the rel­a­tive price of gold far out­paced other com­mod­ity invest­ments. Like­wise, the decline in con­fi­dence after the tech wreck and after 9/11 in the early 2000s pro­duced a sim­i­lar “fear pre­mium” in the rel­a­tive per­for­mance of gold prices. How­ever, between 2003 and 2007, the “fear pre­mium” embed­ded in gold even­tu­ally evap­o­rated once con­fi­dence again revived as the eco­nomic recov­ery matured. A sim­i­lar revival in eco­nomic con­fi­dence may be emerg­ing today. If the Consumer

Con­fi­dence Index does recover to at least 100 in this recov­ery, a good por­tion of the “fear pre­mium” embed­ded in the price of gold may evap­o­rate pro­duc­ing dis­ap­point­ing results for gold bugs.

Sum­mary

Main­tain­ing some gold expo­sure within port­fo­lios makes sense. Should cri­sis fears con­tinue to peri­od­i­cally flare in the next sev­eral years, gold should pro­vide the port­fo­lio with some defen­sive prop­er­ties. How­ever, we believe investors should con­sider reduc­ing gold expo­sure. This is an invest­ment which today seems far too pop­u­lar among the masses, appears extremely over­val­ued rel­a­tive to most other asset classes and faces a chal­leng­ing envi­ron­ment should eco­nomic con­fi­dence slowly improve in the next sev­eral years. The val­u­a­tion of gold rel­a­tive to vir­tu­ally any other asset class (stocks, bonds, real estate or com­modi­ties) seems to sug­gest the price of gold is either extremely rich today and at risk of sig­nif­i­cant decline or sug­gests most other asset classes are very cheap. Either way, it is prob­a­bly time to posi­tion port­fo­lios to ben­e­fit from a slow but steady revival in con­fi­dence rather than in an asset which only “glit­ters” when fear predominates.

Copy­right © Wells Cap­i­tal Management

Tags: Chief Investment Strategist, Commodities, Commodity, Consumer Goods, Diversification, E G Stocks, Glitter, Gold, Gold Price, Government Deficits, Historical Perspective, Last September, Luster, Price Of Gold, Relative Basis, Relative Valuation, Stock Market, Stock Price Index, Stocks Bonds, Time Peak, Valuations, Wells Capital Management, Wells Fargo
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"Patience" (Saut)

Tuesday, March 27th, 2012

“Patience”

by Jef­frey Saut, Chief Invest­ment Strate­gist, Ray­mond James

March 26, 2012

“If there is ever a time when spec­u­la­tors should exer­cise patience, it is in wait­ing for a proper oppor­tu­nity to buy stocks. The desire to make money is at the foun­da­tion of all com­mer­cial and finan­cial trans­ac­tions, but the mere desire to make money should never be the main­spring of spec­u­la­tive action. Knowl­edge or belief based on intel­li­gent analy­sis that a spec­u­la­tive oppor­tu­nity presents itself is the only safe basis for mak­ing pur­chases of stock. It is in for­get­ting that prin­ci­ple that so many spec­u­la­tors err. They do not ask when they are prepar­ing to buy stocks, ‘is the stock cheap and is it sell­ing below its real value?’ [Rather they ask] ‘Is that stock going up?’ The only sound rea­son for buy­ing any stock is that it can be had cheap.”

... R.W. McNell; Beat­ing The Stock Mar­ket, 1927

Bet it sur­prised you that quote is dated 1927. Read it a cou­ple of times away from the mad­den­ing crowd and reflect on it because cer­tain phrases will grab you with their wis­dom. I first read McNell’s book when I was a pup in this busi­ness back in 1971. The insights I gleaned from said book caused me to begin keep­ing three loose-leaf note­books. The first note­book was the “I should have” note­book where I recorded the stocks I had con­sid­ered buy­ing, but didn’t, only to watch them trade higher. The sec­ond note­book was the “I shouldn’t have” book where I recorded the stocks I had bought that I should not have pur­chased because they went down and I was stopped-out of those posi­tions with a loss. The third note­book was the “I did” book where I listed the stocks I had bought that had worked and made me decent returns. The first two books are thick, while the “I did” book is rel­a­tively thin. What I learned from this exer­cise is that when I try to force myself to buy a stock, rather than have the patience to wait for a “fat­ter pitch,” is when I almost always lose money. Indeed, many investors suf­fer from an “action bias,” aka a desire to do some­thing, when in real­ity there are times in the mar­kets when there isn’t much to do. When that occurs the best plan is to do noth­ing and wait for a “fat­ter pitch.”

Obvi­ously, that is what I have been doing since the buy­ing stam­pede ended in late Jan­u­ary. Well that’s not entirely true, because I have actu­ally raised some cash in antic­i­pa­tion of either a pause in the stock mar­ket or a cor­rec­tion. So far it has pretty much only been a pause with an upward bias, which is still bull­ish action. And that, ladies and gen­tle­men, is why I have been con­sis­tent with the state­ment, “You can get cau­tious, but do not get bear­ish!” All in all, I think most will agree the past two months have been very frus­trat­ing with not much fol­low through either on the upside or the down­side. Dur­ing that time frame the NYSE McClel­lan Oscil­la­tor has worked off most of its over­bought con­di­tion. How­ever, the stock market’s inter­nal energy is still com­pletely used up and should take at least another six to seven ses­sions to rebuild. Accord­ingly, if the S&P 500 (SPX/1397.11) stays above the 1375 to 1385 sup­port zone over the next six to seven ses­sions it would be very bull­ish action sug­ges­tive of a con­tin­u­a­tion of the upside run­away we have been expe­ri­enc­ing since mid-December of last year. Fail­ing to hold above those lev­els would likely mean a down­side test into the 1320 to 1340 zone; that is what com­mer­cial hedgers are antic­i­pat­ing. Indeed, for the lat­est week hedgers were net short ~$9.6 bil­lion of the NASDAQ 100 (NDX/2728.55), which is an all-time record. While hedgers are not always right, his­tory does show that mar­kets tend to have a dif­fi­cult time ral­ly­ing when pro­fes­sional hedgers are this bearish.

While the hedgers will be watch­ing this week to see if their bear­ish bets pay off, the Obama admin­is­tra­tion will be watch­ing the Supreme Court because begin­ning today Oba­macare goes to court. I believe this week’s court ses­sion is unprece­dented as the Chief Jus­tice, Mr. John Roberts, has allowed those mak­ing their cases six hours, over three days, for their pre­sen­ta­tions (see the sched­ule on page 3). Typ­i­cally the Supreme Court only grants one to two hours for a case. The oppo­si­tion to Oba­macare will argue that a cit­i­zen should not be forced by the gov­ern­ment to buy any ser­vice. Those in favor of Oba­macare will likely cen­ter on this quote from Wal­ter Dellinger’s spiel to the Senate’s Jus­tice Com­mit­tee on Feb­ru­ary 2, 2011:

“As Jus­tice Scalia observed in his con­cur­ring opin­ion in Gon­za­les v. Raich, ‘where Con­gress has the author­ity to enact a reg­u­la­tion of inter­state com­merce, it pos­sesses every power needed to make that reg­u­la­tion effective’.”

William Eskridge, a law pro­fes­sor at Yale, was inter­viewed in a Forbes arti­cle dated 10/7/2011 on the same ques­tion. To wit:

“The answer, Eskridge says, lies in U.S. v. Com­stock (2010), where Breier writes a broad opin­ion on the Nec­es­sary and Proper Clause, which gives Con­gress the power to take what mea­sures it thinks nec­es­sary to accom­plish its goals. The main case in this area is Mccul­loch v. Mary­land, the 1819 deci­sion that upheld Con­gress’ power to estab­lish a national bank.”

Of course, such argu­ments go to the very core of our gov­ern­ment and the Con­sti­tu­tion. The win­ner of the case will also have a “leg up” in the Pres­i­den­tial race. If Oba­macare is found uncon­sti­tu­tional it should give can­di­date Rom­ney the abil­ity to say – the Admin­is­tra­tion tried unsuc­cess­fully to force more gov­ern­ment on the peo­ple and failed. The quid pro quo is that if Oba­macare is declared con­sti­tu­tional the Admin­is­tra­tion will carry that vic­tory right into the elec­tion. In any event, the very essence of our gov­ern­ment will be decided this week by the Supreme Court.

Amid this Oba­macare uncer­tainty, some­thing fairly unusual has hap­pened, the Health Care Select Sec­tor SPDR (XLV/$36.62) is chal­leng­ing its all-time high. This is unusual because as Michael San­toli writes in this week’s Barron’s:

“It is refresh­ing that investors and ana­lysts col­lec­tively are not enam­ored of the group. It seems that the pend­ing (pos­si­ble) imple­men­ta­tion of the health-care over­haul, and the expected Supreme Court deci­sion on its con­sti­tu­tion­al­ity, has given observers plenty of rea­son to worry over the future eco­nom­ics of var­i­ous med­ical and insur­ance fields.”

In last week’s let­ter I sug­gested par­tic­i­pants watch the KBW Bank­ing Index (BKX/49.53) for the over­all stock market’s near-term direc­tion because the Finan­cials have been lead­ing this year’s charge. Sub­se­quently, the BKX tagged an intra­day high last Mon­day of 50.69 and fell to an intra­day low of 48.77 on Fri­day with an atten­dant weekly fade for the D-J Indus­tri­als (INDU/13080.73) of 1.15%. This week I sug­gest you watch the XLV for glean­ings into how the Supreme Court will rule and what that means for the health­care complex.

The call for this week: I con­tinue to exer­cise patience with the equity mar­kets while I sit on the cash raised over the past num­ber of weeks. Unlike many, I con­sider cash an asset class. Indeed, to assume the invest­ment oppor­tu­nity “sets” that are avail­able to you today are bet­ter than ones that will present them­selves next week or next month is naïve. To take advan­tage of those oppor­tu­nity “sets” one needs to have some cash. For those wish­ing to be more aggres­sive, it looks to me as if the U.S. dol­lar is in the process of break­ing down. If true, and only for a trade, the Mar­ket Vec­tor Gold Min­ers’ (GDX/$49.76) 16.3% mini-crash since Feb­ru­ary 29th should be over. A good stop-loss point would be slightly below last week’s intra­day low of $48.45.

Sched­ule
Mon­day, March 26, 10:00 a.m. – 11:30 a.m.
Oral argu­ments about: Does the Tax Anti-Injunction Act bar judi­cial review of the Patient Pro­tec­tion and Afford­able Care Act until the man­date takes effect in 2014?
Tues­day, March 27, 10:00 a.m. – 12:00 noon
Oral argu­ments: Is the indi­vid­ual man­date con­sti­tu­tional?
Wednes­day, March 28, 10:00 a.m. – 11:30 a.m.
Oral argu­ments: Is the man­date sev­er­able from the rest of the law?
Wednes­day, March 28, 1:00 p.m. – 2:00 p.m.
Oral argu­ments: Is the Med­ic­aid expan­sion con­sti­tu­tional?
Fri­day, March 30
Audio tran­scripts of the week’s oral argu­ments released; and the court decides the case in secret con­fer­ence.
Mon­day, June 25
Court pub­lishes its deci­sion (tentative)

Source: Free­dom­Works

Copy­right © Ray­mond James

Tags: Action Knowledge, Beating The Stock Market, Bet, Chief Investment Strategist, Decent Returns, Financial Transactions, First Notebook, Intelligent Analysis, jeffrey saut, Loose Leaf Notebooks, Maddening Crowd, Mainspring, Patience, Phrases, Pup, Raymond James, Sound Reason, Speculative Action, Speculators, Two Books
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The Case for Chinese Stocks (Koesterich)

Friday, March 23rd, 2012

by Russ Koes­terich, Chief Invest­ment Strate­gist, iShares

China recently mod­estly low­ered its annual growth tar­get to 7.5% from 8%. This change has made many investors ner­vous that China may be in for a period of slug­gish growth.

While investors are rea­son­ably con­cerned about a hard land­ing, I believe such a sce­nario can be avoided in 2012. As a result, I con­tinue to advo­cate over­weight­ing Chi­nese equi­ties for three reasons.

1.) Rel­a­tively Strong Growth Expec­ta­tions: The low­ered growth tar­get isn’t nec­es­sar­ily a pre­cur­sor to a hard land­ing. Why? The government’s 2012 growth tar­get is a rea­son­able esti­mate for Chi­nese poten­tial going forward.

The new tar­get reflects the government’s endorse­ment of a ben­e­fi­cial, long-term rebal­anc­ing of the Chi­nese econ­omy. China can’t, and prob­a­bly shouldn’t, try to main­tain the pace of growth achieved dur­ing the past decade as much of that growth came from fixed invest­ments. In order to cre­ate a more sus­tain­able long-term model, China needs to raise con­sump­tion and mod­er­ate invest­ment, a rebal­anc­ing that will likely help sup­port Chi­nese equi­ties. Cur­rently, China is unusual, even for an emerg­ing mar­ket, in that only about 1/3 of its eco­nomic activ­ity comes from per­sonal consumption.

In addi­tion, even if China grows at 7.5%, it still would be one of the world’s fastest grow­ing economies and the government’s growth goal is typ­i­cally a floor. In fact, actual Chi­nese growth is expected to be in the 8% to 8.5% range this year.

2.) Attrac­tive Val­u­a­tions: Assum­ing China can grow as expected in 2012 and engi­neer a soft land­ing, Chi­nese equi­ties look attrac­tive from a val­u­a­tion per­spec­tive. While Chi­nese stocks are up sig­nif­i­cantly this year, the Chi­nese mar­ket is still down nearly 8% over the past 12 months. It’s now trad­ing for less than 1.7x book value, a sig­nif­i­cant dis­count to where it has traded over the past five years and well below the emerg­ing mar­ket average.

3.) The Infla­tion Out­look: Ris­ing prices were a major prob­lem in China last year, with con­sumer prices up 5.5% in 2011. But infla­tion in China is now decel­er­at­ing. Cur­rently, prices in China are up only 3.2% from a year ear­lier, and infla­tion is expected to stay low for the remain­der of the year. Lower infla­tion will pro­vide more lat­i­tude for the Chi­nese cen­tral bank to loosen mon­e­tary pol­icy, which should fur­ther sup­port the local econ­omy and local stock prices.

To be sure, the Chi­nese mar­ket is not with­out risks, par­tic­u­larly sur­round­ing local prop­erty prices. Still, as I expect China will most likely engi­neer a soft land­ing, the market’s decel­er­at­ing infla­tion, cheap val­u­a­tions and strong rel­a­tive, and rebal­anc­ing, growth make it one investors may want to con­sider. For those look­ing to gain expo­sure to Chi­nese equi­ties, my pre­ferred meth­ods of access are the iShares MSCI China Index Fund (NYSEARCA: MCHI), the iShares FTSE China 25 Index Fund (NYSEARCA: FXI) and the iShares MSCI China Small Cap Index Fund (NYSEARCA: ECNS).

Source: Bloomberg

The author is long FXI

In addi­tion to the nor­mal risks asso­ci­ated with invest­ing, inter­na­tional invest­ments may involve risk of cap­i­tal loss from unfa­vor­able fluc­tu­a­tion in cur­rency val­ues, from dif­fer­ences in gen­er­ally accepted account­ing prin­ci­ples or from eco­nomic or polit­i­cal insta­bil­ity in other nations. Emerg­ing mar­kets involve height­ened risks related to the same fac­tors as well as increased volatil­ity and lower trad­ing vol­ume.  Secu­ri­ties focus­ing on a sin­gle coun­try and invest­ments in smaller com­pa­nies may be sub­ject to higher volatility.

Copy­right © iShares

Tags: 7x, Attractive Valuations, Chief Investment Strategist, Chinese Economy, Chinese Growth, Chinese Market, Chinese Stocks, Economic Activity, Economy China, Emerging Market, Growth Expectations, Growth Goal, Growth Target, Inflation Outlook, Personal Consumption, Precursor, Rebalancing, S Endorsement, Sluggish Growth, Term Model
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