Stocks are racing for year-end as investors would like to lock in 2009 profits. Earning season is over and Christmas Season is just beginning. It looks like shoppers came out in droves for Black Friday but most customers were focused on bargains and buying necessities. It also looked like online shoppers spent 35% more this year than last on Friday according to web analytics firm Coremetrics. It appears the Internet buying was very focused and pre-planned as shoppers spent less time on-line than last year even though purchase volume increased.
Even with some positive early signs, we still expect Christmas won't be a great season for retail sales. Perhaps revenues will rise but gross margins will be squeezed. Retailers will be primarily relying on overhead cost cuts and limited inventory. This holiday season will likely bring cheer to the most price focused retailers like Amazon and Walmart while bringing frowns to many others.
When 2009 comes to a close, the consumer will still be focused on saving and deleveraging. The stimulus plan will still be the driving force for economic growth;but limited bank lending, a weak job market, soft housing sales and the many other problems emanating from the financial crisis will still be overhanging the markets for 2010.
Although we have been cautious in the markets as we expect the economy to limp along, we are most concerned with what we don't know. We believe there are many unknown obstacles ahead which could be devastating for stocks and in turn become a shock to the financial system. What are the implications for the Dubai Debt Crisis? How about the Russian Terrorist Attack? Iran announced a build up of their Nuclear Sites. Will this lead to Israel attacking Iran in 2010? Any one of these events could be the impetus to some unknown chain reaction that could cripple the global economy and lead to new financial stresses.
China has been the driver of the global economy as it buys commodities around the world and builds its own domestic infrastructure and industrial base. Chinese banks may be overextended and its industrial capacity may be overbuilt. If China's growth slows or its banks face defaults from its aggressive lending, what will happen to the world economy? Will China be a seller of U.S. Treasuries and where will interest rates go?
Oil is much higher than it was a year ago but an Israeli conflict in the Middle East could send it much higher. Higher energy prices will certainly send the economy back into recession and perhaps create another financial meltdown. We are not predicting any of these scenarios for 2010 but we do believe the risks are high for some uncertain event to occur. Investors want to be bullish,as do we,but maintaining ample liquidity and hedging for unforeseen events is the prudent way to invest in this volatile economic environment.
Sunday, November 29, 2009
Monday, November 23, 2009
The Bernanke Bubble
The stock market continues to rise, albeit with some volatility. We have been cautious for months and have raised cash while also keeping exposure to stocks. It appears to us that most investors have the same information about the economy but some are bullish and some are bearish. When one looks at the data everyone seems to be right but it is all about timing.
The third quarter seems to be the turning point of the recession. Government stimulus drove auto sales and new home purchases. The Federal Reserve has orchestrated low interest rates and the capital markets have opened to large companies. Banks have increased their capital and their liquidity but have not dramatically expanded their loan portfolios. In the depths of the Great Recession, the consumer stopped shopping and businesses slashed staff while production halted. When panic subsided as the markets were rising, consumer confidence rose a little and businesses began to replenish inventories. All this contributed to the 3rd Quarter GDP growth.
With low interest rates, the dollar has been sinking. This has lead to a rising stock market but it is definitely climbing a Wall of Worry, as it should. Commodity prices, oil, and gold keep climbing and a weak dollar will exacerbate that trend. Unfortunately, government debt continues to bloom. Debt is everywhere from the consumer, to business, to real estate, to all governments globally. As long as rates stay low, investors are predicting economic activity will improve and the U.S. government can finance their needs cheaply.
So far, all investors agree with the above scenario, whether one is a bull or a bear. The other key factor driving some growth is China. China holds the cards to not only global growth but low interest rates in the U.S. Now we must highlight where the two camps may differ.
China is still growing at high single digit rates but the U.S. was a driving force to their exports. Bears are concerned that China is spending tons of capital to build domestic infrastructure which may be creating its own bubble if their standard of living doesn't improve. They have also been driving commodity prices through large purchases in order to fill their domestic manufacturing needs. Those purchases have been kick starting the growth of many natural resource economies. What happens if China can't maintain this growth?
China holds many of the cards. If their growth slows, so does most of the world's. The U.S. would likely suffer immensely. What is more troubling is the amount of U.S. debt China holds. China has been a big buyer of U.S. treasuries for many years. If they suddenly decide to stop buying or worse they become sellers, the interest rates in the United States will begin to rise. Our fear is that those rates may reach levels that will be extremely damaging to our economy.
Furthermore, the towering government debt will grow significantly when we add in healthcare, medicare, and social security funding. How can the United States pay all this debt off? We are seeing the beginning trend in the dollar as the answer to that question. We believe the dollar weakness is due to the Federal Reserve keeping rates low and concerns with the growing debt balances in the U.S.
Given these concerns, how can stocks keep rising? Low interest rates may persist for a while longer as the Federal Reserve floods the markets with liquidity. Inflation has been tame because the velocity of those additional dollars is low. This velocity may not accelerate if employment stays high and lending is curtailed. If the economy actually kicks into high gear, the Fed will have a new juggling act to perform to keep rates low. This scenario will lead to rising inflation. Bullish investors expect rates to stay low, dollar weakness to be positive in the short-term, the economy to be strong in 2010, and unemployment to improve next year.
Our concern is that the Government Stimulus has been a big driver of recent growth and low rates created by the Federal reserve is a catalyst for the weak dollar and improved capital markets. Eventually, markets will need to act on their own and the results may not be pretty. The Federal debt is high and getting higher. State and Local Governments are bleeding huge deficits. The answer in many cases is to raise taxes. Can the consumer or business afford more taxes? The bottom line is that bubbles are being built in stocks and bonds and as long as rates are low, maybe that trend will persist. We remain cautious because we know there will be a day of RECKONING. It is not If, it is When. We are just trying to figure out how to protect our assets. Gold will clearly be a beneficiary but U.S. assets will have to be devalued and interest rates will likely skyrocket in order for the United States to fund its enormous debt.
The third quarter seems to be the turning point of the recession. Government stimulus drove auto sales and new home purchases. The Federal Reserve has orchestrated low interest rates and the capital markets have opened to large companies. Banks have increased their capital and their liquidity but have not dramatically expanded their loan portfolios. In the depths of the Great Recession, the consumer stopped shopping and businesses slashed staff while production halted. When panic subsided as the markets were rising, consumer confidence rose a little and businesses began to replenish inventories. All this contributed to the 3rd Quarter GDP growth.
With low interest rates, the dollar has been sinking. This has lead to a rising stock market but it is definitely climbing a Wall of Worry, as it should. Commodity prices, oil, and gold keep climbing and a weak dollar will exacerbate that trend. Unfortunately, government debt continues to bloom. Debt is everywhere from the consumer, to business, to real estate, to all governments globally. As long as rates stay low, investors are predicting economic activity will improve and the U.S. government can finance their needs cheaply.
So far, all investors agree with the above scenario, whether one is a bull or a bear. The other key factor driving some growth is China. China holds the cards to not only global growth but low interest rates in the U.S. Now we must highlight where the two camps may differ.
China is still growing at high single digit rates but the U.S. was a driving force to their exports. Bears are concerned that China is spending tons of capital to build domestic infrastructure which may be creating its own bubble if their standard of living doesn't improve. They have also been driving commodity prices through large purchases in order to fill their domestic manufacturing needs. Those purchases have been kick starting the growth of many natural resource economies. What happens if China can't maintain this growth?
China holds many of the cards. If their growth slows, so does most of the world's. The U.S. would likely suffer immensely. What is more troubling is the amount of U.S. debt China holds. China has been a big buyer of U.S. treasuries for many years. If they suddenly decide to stop buying or worse they become sellers, the interest rates in the United States will begin to rise. Our fear is that those rates may reach levels that will be extremely damaging to our economy.
Furthermore, the towering government debt will grow significantly when we add in healthcare, medicare, and social security funding. How can the United States pay all this debt off? We are seeing the beginning trend in the dollar as the answer to that question. We believe the dollar weakness is due to the Federal Reserve keeping rates low and concerns with the growing debt balances in the U.S.
Given these concerns, how can stocks keep rising? Low interest rates may persist for a while longer as the Federal Reserve floods the markets with liquidity. Inflation has been tame because the velocity of those additional dollars is low. This velocity may not accelerate if employment stays high and lending is curtailed. If the economy actually kicks into high gear, the Fed will have a new juggling act to perform to keep rates low. This scenario will lead to rising inflation. Bullish investors expect rates to stay low, dollar weakness to be positive in the short-term, the economy to be strong in 2010, and unemployment to improve next year.
Our concern is that the Government Stimulus has been a big driver of recent growth and low rates created by the Federal reserve is a catalyst for the weak dollar and improved capital markets. Eventually, markets will need to act on their own and the results may not be pretty. The Federal debt is high and getting higher. State and Local Governments are bleeding huge deficits. The answer in many cases is to raise taxes. Can the consumer or business afford more taxes? The bottom line is that bubbles are being built in stocks and bonds and as long as rates are low, maybe that trend will persist. We remain cautious because we know there will be a day of RECKONING. It is not If, it is When. We are just trying to figure out how to protect our assets. Gold will clearly be a beneficiary but U.S. assets will have to be devalued and interest rates will likely skyrocket in order for the United States to fund its enormous debt.
Thursday, November 5, 2009
Does Cisco Have It Right?
John Chambers, CEO of Cisco, is one of the most forthright executives in the business world. He tells it as it is and he believe the economy has bottomed and demand is picking up. Most people would agree the recession looks like it has seen the worst days and there is some positive momentum. The key is how strong of a recovery will we get. Mr. Chambers was clearly cautious about being too bold on the growth prospects other than to say the outlook is better but growth is likely to be slow. The stock market appears to believe the economy may have good growth in 2010.
Look at the productivity numbers. 9% improvement is unheard of but labor costs are dropping fast. A little bit of revenue growth is likely to produce strong earnings. There are still many caution flags to watch out for such as the weakened consumer, the limited small business lending, the dismal prospects for commercial real estate, and let's not forgot the unemployment picture.
Investors were happy to see stronger unemployment results but how happy can we be when 500,000 plus jobs are still being lost every week. We historically focused on continuing claims as the key indicator for the employment picture but as unemployment benefits are running out for many people, a drop in this number may not really be a good sign.
Tomorrow is likely the day when unemployment will hit 10%. If that happens and the markets continue to roar ahead, then perhaps we can rally to year end. We would remain very cautious as volatility is back and fear is rising. The stimulus package has propelled a big part of the GDP growth and the government is reinstating the new homes credit to keep that train chugging.
The White House boasts about the hundreds of thousands of jobs they created or saved with stimulus money, but is the cost to this country's future worth it? We may be too concerned about the dangers ahead and stocks may continue their rise but there will be a day of reckoning as the bloated balance sheet of the United States will need to be addressed. It is just another bubble waiting to pop. Enjoy the ride in the short-term but make sure you have some hedges along the way.
Look at the productivity numbers. 9% improvement is unheard of but labor costs are dropping fast. A little bit of revenue growth is likely to produce strong earnings. There are still many caution flags to watch out for such as the weakened consumer, the limited small business lending, the dismal prospects for commercial real estate, and let's not forgot the unemployment picture.
Investors were happy to see stronger unemployment results but how happy can we be when 500,000 plus jobs are still being lost every week. We historically focused on continuing claims as the key indicator for the employment picture but as unemployment benefits are running out for many people, a drop in this number may not really be a good sign.
Tomorrow is likely the day when unemployment will hit 10%. If that happens and the markets continue to roar ahead, then perhaps we can rally to year end. We would remain very cautious as volatility is back and fear is rising. The stimulus package has propelled a big part of the GDP growth and the government is reinstating the new homes credit to keep that train chugging.
The White House boasts about the hundreds of thousands of jobs they created or saved with stimulus money, but is the cost to this country's future worth it? We may be too concerned about the dangers ahead and stocks may continue their rise but there will be a day of reckoning as the bloated balance sheet of the United States will need to be addressed. It is just another bubble waiting to pop. Enjoy the ride in the short-term but make sure you have some hedges along the way.
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