A Market Correction or a New Bear Market?

After the events of the past two years, it is understandable that the markets are so volatile. As I have indicated previously, the expectation of a market correction has been in the works since the latter part of March and most certainly after mid-April. My own expectation was for a brief correction of about 7%. When the markets get to a point where they are overbought, then a correction eventually comes. The question is when something will happen and what will trigger the change. In this case, the debt of the PIIGS (Portugal, Ireland, Italy, Greece, Spain) was the catalyst worldwide to bring about a rapid descent. At the beginning of 2010, the S&P 500 opened at 1117 and by April 23rd it had reached 1217, up 100 points or almost 10%. Between April 24th and May 7th,the market went down to 1111 for a drop of about 8.7% and below the opening at the beginning of the year. The bond market acted in a similar fashion with interest rates decreasing until the scare from the PIIGS moved interest rates up and the value of bonds down. The action over the weekend to bolster the euro, with a commitment of $1 trillion, was a bold and needed move to keep the financial markets and economies of the world moving away from the recession. The impact worldwide has been dramatic and good. But how about the fundamentals? So far, 381 companies that make up the S&P 500 have reported earnings, and of these 77% have topped estimates. The S&P 500 index is trading at 13.5 times forecasts for earnings during the next four quarters while the long term average for this multiple is 16.4%. This would imply that there is still room for stock price growth. All of this was before Friday's meltdown. If the PIIGS situation remains stable, then it is likely the markets will resume their path higher. I am not complacent at this time because we in the US need to do something about our own Federal red ink! I am hopeful that we will see the light and move to reduce the deficit spending once the broad economy is out of the woods. For now, we continue on a positive path with very large job creation in April (I was thinking 200,000 but instead it was 290,000), inventories being replenished and businesses increasing spending. The signs for a recovery are looking good! Ed

Giddy Yap!

In my recent newsletter I had indicated that I thought the picture for unemployment would improve. I think this is good news: the state unemployment benefit claims fell by 40,000 this past week, and the Federal claims fell by 500,000. This means, based on my calculations, the following: the unemployment based on state claims fell from 9.7% to 9.6% and, more meaningful, the federal claims fell from 12.5% to 11.3%. Overall, the jobless rate, while still very high, moved from over 22% to 20.9%. I will be happy to see this continue. In another bold move, housing sales were up 27% in March, the highest in 47 years. It is likely that April will also see housing sales rise, because the requirement to have an executed sales contract, to get the federal tax credit for a home purchase, expires at the end of this month. It appears we are moving forward. Ed

Jobs, Jobs, Jobs!

Back in my November 3, 2009 blog, I indicated that I thought this recession (depression is more like it for the number of people out of work … but more on that later) was very similar in some ways to the period of 1973-74, followed by the recovery of 1975. My remark was specific to my belief that we would not see a lowering of job losses and increasing jobs creation until March of 2010. At the beginning of March, I again commented on my belief as the Labor Department reported the four-week rolling average of job losses was 470,750. It now appears that March was a turning point. The four-week rolling average of job losses, as of Thursday April 1st, was 447,250, just below the 450,000 that most economists were seeking. More importantly, the number of new jobs created, according to the Labor Department, was 162,000. This was the biggest gain since December of 2007. What I like is that, according to their report, private employers created most of these jobs. I must say, however, on a negative note, that while unemployment remains at 9.7% as the government counts the data, I count it somewhat differently. The 9.7% represents 4.66 million people who are receiving state benefits, but not the 6 million people who are on extended federal benefits that add up to an additional 73 weeks. My math says that the additional 6 million people represent 12.5% in addition to the 9.7%, or over 22% unemployment. This is a big number and most of us know at least one person, or many more, who are currently out of work! Is there hope for the unemployed? I think so. As I’ve also mentioned on several occasions, this recession seems somewhat like the one in the ‘70s. In May of 1975, hiring picked up pace very quickly and expectations of a long period of unemployment were proven wrong. We shall see as this unfolds. Ed Mallon

The Federal Reserve Rules!

It has been interesting to be able to look back on the economic collapse we have experienced in the past couple of years. While the central government of the U.S. rattled cages, set out on a journey of legislation, and argued about bailout funding the Federal Reserve (Fed) took action. Not only, as it turns out, did they take action, but they took it quickly and decisively. The Fed dramatically lowered short-term interest rates and washed the country with money supply. Last week it was reported that because of their actions, the economy was saved! As far as the bailout money was concerned, even after it was approved, the government was slow at spending it. It helped the economy, but the Fed saved the day! Only a couple of months ago, Congress was on the case of the Fed with the idea of curtailing its power. Now, interestingly, Senator Dodd is proposing financial reform legislation that would give the Fed oversight for the financial markets and instruments not currently regulated by any other part of the government (such as the derivatives that help create this mess). The Fed is not perfect. In making interest-free money available to banks and investment banks during this period, these giants were given the ability to take money from the Fed, paying no interest, and to invest it at interest. The difference, known as the spread, is the profit that the big banks and investment banks were allowed to keep. The nasty part of all of this is that instead of plowing this back into their companies, much of this money was given in the form of outlandish bonuses for the year 2009 and likely will be followed by even more extravagant bonuses in 2010! The Fed is aware of this and is gradually reducing the money supply and charging a modest interest rate. It is the old story that, for the betterment of the country, the big guys will get rich! Long term, we must remember that the people who are on the Fed wield a great deal of power and these are appointed positions still subject to political whims. Ed

Mixed News

It appears the economy is giving us some very mixed signals these days. Consumer confidence seems to be going down, the Federal Reserve says the economy is edging up but at a very slow rate and Congress still has done nothing with employment legislation. The initial claims for unemployment insurance, which was widely anticipated, showed a drop of 29,000 from the prior week to a seasonally adjusted 469,000. This reversed the big rises of the past two weeks. Still the four week average is 470,750 where it had been down to about 450,000 a couple of months ago. Back in November I had anticipated that we would see a marked decrease in initial claims beginning in March since this is what has happened in the past. We will see as the month progresses. With productivity rising, according to the Department of Labor, in the fourth quarter of last year by 6.9%, it would seem that fewer workers are working more hours. At some point we would expect that with the addition of part time, tempoary and over worked workers companies would once again begin to hire full time employees. In the meantime, the consumer is watchful and curtailing spending and thereby keeping inflation down. The overall economic trend appears to be moving up at a slow pace. Ed

Inflation and Bonds

Bonds do not generally work well in an inflationary environment. When inflation rises, interest rates also tend to rise. Unfortunately, rising interest rates mean that existing bond values decline. This occurs because an investor can now get a higher interest rate on a new bond than on an older bond. To offset this difference, old bond prices are discounted (reduced) to give investors the same basic rate of return on either old or new bonds. The longer the time to the maturity of the bond, the greater the discount tends to be in the reduction of the bond’s price. This is an area that I have been watching carefully for the past year. In 2009, we were fortunate that interest rates decreased and the value of the bonds increased. This year, it has been a bit of a seesaw, with interest rates fluctuating within a fairly narrow range. In this environment, we have been looking toward moving from very short maturities (60 days to two years) with very low interest to the higher interest on longer-term bonds (average maturity of 4 to 5 years). My confidence in this position comes from seeing core inflation remaining reasonable and consistent. This consistency in the inflation rate should lead to consistent interest rates on longer-term bonds for the next several quarters. The bad news is that the current control of inflation appears to be in large measure because of continuing unemployment and growing layoffs. Overall, the bond market likes stability, and even with the massive federal bond offerings, bonds do seem to be stable. 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