Bad News Keeps Coming

Manufacturing contracted in September at the fastest pace we have seen in 36 years. Exports are also falling off a cliff as are auto sales. In fact, October represented the worst sales month for the auto industry since World War II. Wait until Friday when employment numbers are reported. They will be quite ugly and the unemployment rate is no doubt going to rise. With all this bad news, the stock market barely moved today and closed virtually unchanged. The quiet market presumably is related to the Presidential Election tomorrow.

Market pundits are starting to say if stocks aren't going down on the bad news, we must be at a bottom. We believe a bottoming phase has begun but the market will retest the October 10th lows again as the economy continues to weaken in the fourth quarter and companies once again lower guidance. As we have been saying, stocks discount the future earnings weakness but this recession will be deeper and longer than most investors presume.

Most companies are reluctant to forecast what will happen in 2009 until they see some stabilization in their businesses. The consumer, who has lost a large part of his/her net worth from their homes, is financially weakened. If they can't pay off their credit card bills or their auto loans, it will only be a short time before they don't pay their doctors and lawyers. Hence, no luxury shopping is on the horizon and only necessary staples will be purchased. The holiday season will be bleak, as we have been saying for a couple of months, and cyclical companies might be shocked at how bad business can actually become.

In looking for new stock investments, make sure to peruse the balance sheets of companies in which you want to invest. These are the times when rising accounts receivable and bloated inventories will be the sure signs of trouble looming. Companies tend to extend more credit to their customers in weak economic environments in order to generate sales but it may also lead to rising bad debts. Retailers and distributors may also curtail purchases of new goods as their sales slow which may leave unwanted inventories at the manufacturer. The manufacturer will in turn cut production as their sales slow. Companies who are growing fast sometimes get caught off guard by this unexpected sales slump. If such a scenario happened to a company like Apple, the stock would dive. It is important to be cautious and not chase the market.

Most companies have are prudently managing their businesses in these trying economic times. We haven't heard any cyclical company forecasting better times in 2009 as they can't even figure out what is likely to happen in the fourth quarter. However, Mohawk Industries, a stock we have been short, reported third quarter numbers which were slightly weaker than analysts expectations. The company said they expect a weak fourth quarter also but 2009 would be a better year. Mohawk manufactures flooring products for homes and commercial buildings. It is amazing that they must be the only company that can predict an upturn in the housing market, a better commercial real estate environment, and a stronger consumer. We believe they will start to extend more credit to their customers as internal sales forecasts lag their expectations. Housing renovations will not likely pick up in the near future and new home construction is nowhere in sight. As for commercial real estate, it is just about to get weaker. Mohawk is a great company but the economic cycle is likely to still negatively impact their business.

The markets may be quiet tomorrow until polls start reporting expected results of the election. A McCain victory could cause a rally as businesses would be spared some taxes and capital gains will be preserved. If Obama wins, we have to believe he will become realistic and not raise taxes in 2009 but defer the thought until the financial crisis and the faltering economy are well behind us. The next topic of discussion for the markets will be: Who is going to be our next Secretary of the Treasury? We like the thought of Tim Geitner, the New York Fed President. His involvement throughout the financial crisis might lead to a smooth hand off of the baton from Hank Paulson.