Of Course Housing and Auto Sales Are Up

The markets reacted well to strong existing home sales last week as they did when domestic auto sales jumped in July. It should be no surprise to anybody that those have been two extremely damaged areas in this recession. The Obama administration may have a trillion dollar Stimulus Plan but it is likely that only their assistance in buying homes and cars may be the only two line items that will directly grow sales and add to employment. It is working albeit at a big cost to Americans.

It is also unlikely that such programs will have lasting affects. Consumers always like a bargain and that is why they are gravitating to Walmart, TJ Max, McDonald's, and other discount retailers. So when the government handed out free money to buy cars and homes, consumers jumped for another bargain. Unfortunately, those programs won't last forever and this economy needs some other sources of demand to jump start growth.

99% of employment growth comes from small-businesses but 99% of news headlines comes from large corporations. The National federation of Independent Business announced the results of their July survey of small-businesses. The results are bleak. Small-business owners aren't convinced the recession is ending and their outlooks darkened in July. The recorded index declined for the second month in a row and the biggest reason for the drop was that small-business owners don't expect the economy to improve in the next six months.

This shouldn't be much of a surprise as financial institutions still haven't opened the lending spigots, sales remain weak, taxes may be rising, and the cost of health care is uncertain. The consumer is still weakened and their inclination to increase savings will keep the small-business owner concerned.

We continue to wonder why stocks keep rising but it seems pretty simple. Stocks were in free fall when the prospects of the Second Great Depression was looming. Investors ran for cover and focused on capital preservation with minimal risk. Now it appears that the recession has come to an end and the trillions of excess liquidity is looking for a place with higher risk and improved returns. Companies are reporting better earnings and investors seem to overlook the negative news and focus on the green shoots.

Stock prices must reflect the realities of corporate growth and the discounted cash flows of earnings. Bull markets climb walls of worry and we remain worried. We see improvement in the economy but we also see the plethora of risks ahead. The financial industry calamity we had can be attributed to poor risk management. Housing prices were expected to rise forever and leveraged financial instruments were viewed as gold. Consumers, businesses, and financial institutions yearned for more and more so they piled on debt. It was just a game of musical chairs until the music stopped.

We may be in a similar game of musical chairs. The logic is that the recession is over and investors need higher returns. They step back into the stock market and feel much better as stocks have risen. Others missed the rally but need to get on the train so they take their over abundance of cash and enter the market which in turn pushes stock prices even higher. Housing sales and auto sales confirm an improving economy and more investors become comfortable taking the ride on the stock market express. Is this a ride to riches or are we at the top of the roller coaster?

We wish we knew the answer. We believe stock prices have risen too far, too fast. Business is improving but true growth is small. Until the consumer is back and small-business confidence improves, we will remain concerned. We still own stocks but writing covered calls and adding stop limit orders seems to be the best way to minimize risk. We may be giving up the upside if stocks continue on the current trajectory but investors need to focus on risk management.