“Ich bin ein Berliner”
November 07, 2011
by Jeffrey Saut, Chief Investment Strategist, Raymond James
"Ich bin ein Berliner" was a German phrase used by President John F. Kennedy in his famous Berlin speech where he was emphasizing the U.S. support for West Germany after the Soviet-supported East Germany erected the Berlin Wall as a barrier to prevent movement between East and West Berlin. Last week at the G20, like John Kennedy, President Barack Obama tried to emphasize America’s support for a German bailout plan to prevent a Greek tragedy. The tragedy’s trajectory rose sharply on Tuesday when Greek Prime Minister George Papandreou announced there would be a referendum to decide if the new austerity measures for a second bailout (the first was on July 21, 2011) would be acceptable to the Greek people. That news shocked the world’s equity markets, which was reflected by the Dow’s Dive of some 297 points. I was seeing portfolio managers at the time and told them that in my opinion Papandreou’s prose was telegraphing a Greek withdrawal from the EU. A withdrawal because the Prime Minister knew the Greek people would never vote for such measures and because the vote most likely would not be held until next year. Further, Papandreou knew that given the uncertainty of an austerity vote the IMF would probably hold back its already scheduled disbursement of funds. To be sure, the IMF’s funding conditions require a clear horizon for 12 months, so Greece’s €8-billion tranche, which would come from the IMF, probably would have never showed up.
A Greek withdrawal from the Euro-zone would also be quite messy. Firstly, leaving the euro and returning to the drachma should cause a sharp devaluation in the drachma’s value vis-à-vis other currencies. A good example of this is the monetary breakup of the Austro-Hungarian Monetary Union in 1919. Secondly, the switching of currencies requires changing domestic laws to allow wages and incomes to be paid in the new currency. As well, domestic debt has to be recalibrated for the new currency. Thirdly, Greece’s government would be unable to borrow from the financial markets and thus forced to cut its budget deficit to zero. As The Wall Street Journal notes:
“[Greece’s] debt burden – the weight of government debt as a proportion of economic output – would soar. The economy would shrink as the new national currency depreciated against the euro, but most of the government bonds would still be euro-denominated. If that weren’t enough, many economists argue that the economic benefits of a sharp currency depreciation could quickly be dissipated by wage inflation.”
Then there are things like preparing for capital flight, bank holidays to slow withdrawals, reprogramming cash registers/vending machines/etc., making new notes and coins, well you get the idea. Indeed, it’s all Greek to me ... pass the ouzo!
Comes Thursday, however, Papandreou drops his controversial referendum proposal as he faced a “no confidence” vote on Friday. Interestingly, he survived that vote, but surprisingly the DJIA (11983.24) didn’t follow on to Thursday’s Triumph (+208.43). And that, dear reader, raises the question – is the stock market merely reacting to the on/off news from Greece and the EU? – or, has the October rally been more about the better than expected economic news in the U.S.? Our sense is the rally from the “undercut low” of October 4, 2011 has been driven by better than estimated economic reports. Verily, the economy has been doing better than most expected. For example, the recent real GDP report showed an uptick to 2.5%. But, the real GDP, less the change in private inventories, increased by 3.6% (seasonally adjusted annual rate) during 3Q11 versus +1.6% in 2Q11. This suggests companies chose to meet the stronger demand by selling inventories rather than increasing output. This only reinforces our belief that corporate America will have to build inventories, which should add ~1% to this quarter’s GDP report. Then there was the strength in producers’ durable equipment, which jumped 17.4% during 3Q11. Hereto, this plays to our argument that spending on capital equipment (capex) should torque up into year-end, spurred by the ability to expense capex. The fear here is that the 100% expensing feature is slated to expire on December 31, 2011 unless it is extended.
As stated in last Monday’s missive, about three-quarters of October’s economic releases have been coming in better than expected. Unfortunately, that skein was broken last week with seven of the 18 economic releases better than estimates, eight weaker, and three in line. And maybe that, rather than Greece, was the reason for the early week two-day train wreck of down 573.15 points for the senior index. The downside two-step registered back-to-back 90% Downside Days whereby both the declining volume, and the number of downside points, equal or exceed 90% of the total volume and total points traded. Typically, such back-to-back Downside Days tend to temporarily exhaust the sellers, which was the case last week as Wednesday and Thursday’s sessions recorded back-to-back 80% Upside Days. For the past few weeks we have been suggesting some kind of pause/pullback was due, commenting that the McClellan Oscillator was about as overbought as it ever gets. Ditto the percentage of stocks in the S&P 500 (SPX/1253.23) that were above their respective 50-day moving averages (only 4% in early October versus 93.6% as of last Monday morning); and the fact that according to our “day count” sequence, with October 27th being session 17 in the typical 17 – 25 Buying Stampede, the straight up rally was long of tooth.
As for earnings season, earnings continue to track above expectations as with 432 companies in the S&P 500 reporting, earnings are better by 22.2%, with a 12.2% increase in revenues, year over year. The question then arises, “Why are fundamental analysts lowering their forward estimates?” Indeed, there have been noticeable declines in estimates for eight of the S&P’s ten macro sectors. The two sectors where estimates have not been lowered are Healthcare and Utilities. Nevertheless, it has indeed been a great earnings season and we expect more of the same into the Christmas selling season. To that point, there is a high correlation between strength in the stock market and a good Christmas “sell through.” Accordingly, we expect a decent Christmas and suggest investors consider select retailers as investments. As the keen-sighted folks at the Bespoke Investment Group opine:
“In order provide a more detailed look at the performance of retail related groups’ pre and post Thanksgiving, in the table we show the annual returns of the S&P 500, the S&P 500 Retailing group, as well as the various subgroups in the Retail sector from the start of November through Thanksgiving. From 2000 through 2010, the S&P 500 has averaged a gain of 0.9% from 11/1 through Thanksgiving with positive returns nearly three quarters of the time. Retailers, on the other hand, have done even better. From 2000 through 2010, the S&P 500 Retailing group has seen an average gain of 1.6% with positive returns nearly two-thirds of the time. Looking at individual sub-groups shows that Internet retailers (beginning in 2002) have seen the best returns in November with an average gain of 4.8%. After online sales, the next best groups are Apparel (3.1%) and Restaurants (2.8%). If you are looking to generate alpha, both of these groups have outperformed the S&P 500 73% of the time since 2000.”
Some Strong Buy-rated names for Raymond James’ universe of stocks playing to this theme are: Bed Bath & Beyond (BBBY/$62.03); Big Lots (BIG/$41.32); Family Dollar Stores (FDO/$58.97); O’Reilly Automotive (ORLY/$76.90); Red Robin Gourmet Burgers (RRGB/$26.57); Select Comfort (SCSS/$20.77); and Wal-Mart Stores (WMT/$57.50).
The call for this week: Last Monday I wrote, “To us, the real question is – will the SPX get a pullback to the often mentioned pivot point of 1217, or will any pullback be short and shallow? Well, by our work the equity markets still have a lot of internal energy to power their way higher, so our sense is the SPX will keep pushing higher in the months ahead with only shallow pullbacks and sideways pauses along the way.” While falling from 1284.59 to 1218.28 the first two days of last week hardly qualifies as “shallow,” I do find it interesting that on the numerological date of 11/1/11 the S&P 500 closed near the aforementioned pivot point of 1217 and then rallied. Accordingly, we would view a decisive close below that 1217 pivot point as a negative, suggesting a decline back into the 1100s. A more likely outcome, however, is for the SPX to spend some time consolidating before resuming its advance.
P.S. – I am actually here all week ...
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