"Stocks are Dead!"

In section C of the Wall Street Journal on Wednesday, August 1st, the headline read: "Bill Gross: Stocks are Dead and Operate Like a 'Ponzi Scheme'”. It notes that Bill Gross is co-founder and co-chief investment officer of Pacific Investment Management Co., or PIMCO, the largest bond fund in America. His belief is that the rates of return seen with stocks cannot continue and in the long run will come down. At the time this was reported, the 10-year Treasury bond was yielding about 1.5%. As of today, the same bond is yielding 1.84%. While this may not seem like much of a change, it means that the 10-year Treasury bond has decreased in value in a matter of 17 days. With bonds, when the yield rises, the value of the bond declines. Putting it in dollar terms, if you hypothetically purchased $100,000 of 10-year Treasuries at the beginning of the month, the value of your money would have decreased about $2,800 by last night. Because Treasuries impact most bond yields, we have also seen similar drops in value for most bonds. During the same period, the S&P 500 has risen 36 points for a 2.6% increase. If you had hypothetically purchased $100,000 of the S&P 500 Index, your money might have increased by about $2,600. Trying to guess the direction of the stock market or bond market over short periods of time is futile. I do believe there are long term trends that need to be watched, as well as short term events that must be taken into consideration. For bonds, with the long term trend from 1981 until now, we have seen interest rates continue to fall and as they fell, the value of bonds increased. Will this hold for the future? I don’t think it will. I believe bonds must ultimately begin to have increasing interest rates and reductions in value. The reason for holding bonds now is because of the uncertainty in the U.S. and the world, and the long term stability of bonds is because of the priority in payment, both interest and principal, of bonds over preferred and common stock. As greater stabilization comes to the U.S., and the world situation plays out, the benefits of stocks, dividends and growth, will be more likely to outweigh the stability of bonds. The ultimate answer to our current situation and long term investing is diversification. Bonds go up and down, stocks go up and down, real estate goes up and down, currencies go up and down and commodities go up and down! These changes happen because of economic trends but also because of human emotion. The three rules of investing are: Diversify, Diversify, Diversify! Have a great weekend! Ed

Hey, Wait for Me!

You might be wondering where the stock market is going these days. As of the close on September 13th, the DJIA had gained 5.3% since August 31st while the S&P 500 was up 7% and the NASDAQ was up 8.1%. My, what is going on? Let's start by understanding that August was a very poor month for the market. To put it in perspective, the S&P 500 was down 6.8% in August. What we have seen, therefore, is a move back to where the market was at the beginning of August. This is not a bad thing; it’s just that you need to remember we don't have a runaway train on our hands! The news has been good. The private sector added about 67,000 new jobs in August. New unemployment claims last week were 451,000 vs. 472,000 the week before (we are looking for that number to go below 450,000 and will be happier at 400,000 or lower). The economy appears to have grown by about 2.85% from the end of September 2009, which is not great, but it is growth. Today, retail sales were reported to be up, which was totally unexpected. In addition, the winds of positive tax reform appear to be blowing in the right direction. The possible large increase in taxes in 2011 has weighed heavily on the markets. The idea of 100% write-off of new plant and equipment investment through next year sits well with me. I think its biggest impact is on large corporations that have lots of surplus cash to spend. The trickle down of this to smaller businesses, which will manufacture all or parts of the plant and equipment, is good. The one bone of contention seems to be taxes on those who earn more than $250,000 each year. The implication is that these are the "fat cats" but history shows us the "fat cats" can always figure a way out of paying taxes. The real burden of this measure once again falls on small business owners who have been massacred during this downturn with little or no help from the government. All in all, the economy is looking better, consumer confidence may be gaining, and the likelihood of a "double dip" is looking far less likely. So how do I feel about the market? Short term, I think it is too high. September is notoriously a bad month for the stock market as investors start to worry about the all-important third quarter earnings. I think that, between now and the middle of October, we may hit a rough spot or two. Looking out to the mid term and long term, I think we are still in a bull market that is going through a correction. Ed Mallon

Weekly Unemployment Up!

The weekly number of new people filing claims for unemployment rose today, which was not good news. In many respects, what is worse is the fact that the rolling four-week number has been moving upwards steadily for the past several weeks. On the other hand, productivity was reported today to be up, as employers try to get the max with the least! From past periods when we have had high unemployment, we have generally seen the unemployment rate rise during the first couple of months of the year before beginning a more favorable decline in March. I think that also will be the case this year. The stock market, however, is not showing much foresight these days and is reacting to what I consider to be yesterday’s news about unemployment. Once again, we shall see what we shall see. Ed

Anticipating Earnings Reports

The initial earnings reports for the first quarter were nothing to write home about and did not impact the stock market. A positive report from Wells Fargo last week, indicating much higher earnings than expected, moved the stock market up. It is possible that reported earnings for the quarter might not be as bad as expected. Bad news and good news appear to set the stock market off very quickly. Today the market started in a down position, seemingly because of weekend news indicating the government’s willingness to let GM go into bankruptcy. While volume remained light for the day the S&P 500 finished in an up position. Thus far we have had five weeks of the market being up. Since earnings expectations are very low, it is possible that the actual earnings figures will come in somewhat better and continue this market rally. We continue to see a disproportionate number of sellers to buyers, which leaves me believing that we are in a correction within a Bear Market and not at the beginning of a new Bull Market. No matter what is causing this upturn in stock prices and lowing of interest rates I am happy to see it and would be even happier if it continues! Ed

Percentages Can Be Deceiving

It's been awhile since the sentiment in the market has appeared positive. With the S&P 500 having come off of a low on March 9th, we have seen a marked improvement in the value of stocks. Remember, however, that this percentage increase is coming from a very low point and that percentages can be deceiving. For example: if I had $100 and it decreased in value to $80, that would be a drop in value of 20%. If that $80 rose in value by 20%, I would now have $96 and still not be back where I started. If you think of the stock market as having dropped about 50% at its low, that means that $100 of investments would now be worth $50. If it were to rise by 20% (sounds like a lot) that would be $10 and we would now have $60. Better than before, but still not good! Percentages can be very misleading. I’d rather see it in dollars so I can understand what is really happening. In six of the seven trading days following the March 9th low, the market was up. In three of the five subsequent days, the market was down. Yesterday, March 25th, the morning saw the DJIA up 200 points. By late afternoon, the DJIA was down 110 points. That is a negative swing of 310 points in a matter of hours. At the close, we had a rally of 178 points with the DJIA showing a nice gain of about 1% for the day. We are likely in what is referred to as a trader’s market. The traders who are buying are not purchasing for long-term investment, but rather to either sell what they don't have (short selling) and buy back in when prices drop, or to purchase when prices are low and sell at the first opportunity to make a profit. In this environment, the supply of stocks available for sale is high while demand is variable. When demand is strong, stocks do well as sellers find willing buyers. When buyers step aside, even for a brief period, the market slides down rather quickly. At this point, the notion that a new bull market has begun is hard to justify. It looks more like an uptrend in a continuing bear market. Confirming this idea is the fact that interest rates, that had decreased earlier in the year accompanying a rise in stock prices, then rose again when stock prices fell, are staying at higher levels than I believe would be consistent with a bull market trend. I am happy with the gains but watchful of where it will lead us. Ed Mallon

Positive Negativity

Good news: Everyone thinks the economy is only going to keep getting worse! It seems that when "everyone" knows something bad is going to happen the worst is often behind us. I was thinking yesterday, as some of the stock market indexes reached new lows in this bear market, about the price of oil just a few months ago. The price had reached about $140 per barrel and the talk was that it was bound to rise to $200 or $250. Very, very few "knowledgeable" people thought it would go down. Where is the price of oil now! Would you believe it has fallen about $100 per barrel to roughly $40. Bear markets generally begin to wane when "everyone" is sure there is no hope! In listening to what has been going on lately it would seem we may be close to that point. Yesterday, when the S&P 500 and the NYSE indexes reached new lows for this market downturn, I found that not many stocks were reaching new lows. This too may indicate that the market is getting to an oversold place and is only waiting for the time when the signal to buy emerges. I have read reports by some that the Dow will drop to 5500. This is possible. I have not been reading much from people who are saying the market could go to 10,000. I think that this, too, can happen. This may not be the bottom, but the sentiment is so bad, and so much negativity has already been built into the price of stocks that we may well be approaching the bottom. After a year and a half of being pessimistic about what is going on, I now feel optimistic! I don't think the ship is going to sink! Ed

Holiday, Followed by Turkey

Last week seemed to be an optimistic prelude to the Thanksgiving holiday. The stock market managed four successful up days followed by a fifth on the Friday following Thanksgiving. Unfortunately, on Monday, the market was a “turkey” and gave back about half of what it had gained during those five up days. Some of this is profit-taking after such a run up, but part of it is that the economic news is still not very good. It has been my belief, and still is, that in order for the economy to move forward, we need to see the interest rates on corporate bonds decrease to a level that makes some sense. This has not happened. Interest rates rose in October and were followed by additional increases in November. If it takes lower interest rates to move the economy, then the stock market cannot do much until lower interest rates occur. Corporate bonds, in some cases, are linked to commercial real estate, and as the economy worsens, the question becomes “what is the value of the real estate that supports the bonds”? There seem to be many questions at present but few answers. The old administration in Washington is wrapping up their loose ends and likely will do little between now and the time that the new administration enters. I had a list of what I would do if I were the President-Elect and I must say that Obama is doing all of the things on my list. He will need to hit the ground running, and to this end he appears to have assembled a competent group to help him launch meaningful economic reform. I wish him well! Ed Mallon

Is This the Turn?

Monday, October 13th saw a gain of 936 points, the greatest one-day point gain in the history of the DJIA. It was also the 5th largest percentage gain for the DJIA at 11.08%. The other four historic double-digit gains were back in 1929-1933. As a matter of fact, the next largest gain was on October 21, 1932 and was followed by a decline that took the DJIA down to 33 points and a bottom in February 1933. The point is that double-digit gains have been characteristic of bear markets. You need to have patience in this market. My personal belief is that the bond markets need to see interest move downward before a real economic change is possible.

Can it rain and be sunny at the same time?

On Monday of this week, the inflation rate for the month of July was reported to be 0.8% or an annualized rate of 9.6%. This compares with an annualized rate in June of 7.2%. This would appear to be bad news because it means the price of goods and services are going up at a much higher rate than the Federal Reserve Board (Fed) would like to see (1.5% to 2.5%). In such a situation, you would expect to see the Fed increase their key interest rate. On Tuesday, the Fed met and left the key interest rate unchanged at 2%. This also means that the prime leading rate stays at 5%. The stock markets took this as good news, with a healthy advance in prices. The bond market took it as bad news with interest rates rising (and therefore the price of bonds declining). It would seem that, with the price of oil falling for the past week and the economy not looking its best, the Fed decided to gamble that prices will stabilize as oil prices are reduced. The lower oil prices could benefit food and transportation costs. This in turn could mean that inflation will be reduced. What we are seeing, in any event, is that the current Fed is more concerned with the economy than with inflation. Ed Mallon

Fearful Headlines

I have been noticing that the headlines used by the media during the past month seem to evoke fear. An example of some of today's headlines: "Oil Prices Plunge More Than $10 a Barrel!" "Fed Chief Details Woes in Markets, Housing, Jobs" "Bush: Troubled Financial System is Basically Sound" "Wholesale Prices Soar in June; Sales are Sluggish" Fear is what many Americans are feeling right now. They wonder if the financial system will be okay and more important, if they will be okay. We are driven by our emotions and the emotions of others around us. The more negative the news, the more negative and fearful we become. We are "news junkies" who need a constant infusion of the "latest news." The problem with all of this is that it does not give us perspective or context of the events happening around us. Most media personalities have little understanding of how the events fit into a broader pattern of economic and social forces. For example: What does oil plunging by $10 a barrel really mean? It likely means that some of the speculation in oil is giving way to more realistic pricing. If this trend continues inflation will be lowered and the value of the dollar strengthened. When the Fed chief details the "woes," do people realize that what he is saying is that the growth we are having is likely to be less than anticipated and that he still expects the economy to grow during 2008? When President Bush talks about the financial system, he is really saying that the government believes that the actions that are being taken by the Fed and Treasury will alleviate the current problems. Saying wholesale prices "soar" is simply saying that the "real inflation rate" which includes fuel and food, is rising at an annualized rate of 13.2 (1.1% in June multiplied by 12 months) as opposed to the "core inflation rate," which does not include the volatile fuel and food sectors, which is rising by an annualized rate of 2.4% (0.2% in June). Real people eat food and use energy! Until June when the Fed finally started to mention the real inflation rate, they had been consistently looking at the core rate of inflation and indicating that inflation was not a big problem. They now "get it" and will do what they need to do to contain real inflation. The inflation rate has meant a higher amount of income is going to essential expenses (food, fuel), leaving much less for other spending. I still believe we are going though a recession that is similar to the one we had in 1990, along with a bear market in stocks. The confluence of a bear market in stocks, a bear market in housing, and rising oil and food prices is unsettling. In the bigger picture, these events are setting the stage for the next new direction of the market. I am already seeing articles about new developments in "Green Technology." Keep oil up in price and, in the long term, the US will respond to become more self-reliant, stronger financially and better disciplined.