Weekly Update: How will you spend your Memorial Day weekend?
I'm going to Indianapolis to see my daughter play in the marching band at the Indianapolis Motor Speedway. What does that have to with investing? Nothing; just getting ready for a boring summer of choppiness. Monday’s rally was overdue, but a run up to 1,340-1,370 on the S&P 500, a 50% retracement of the most recent decline, would likely meet resistance. The S&P is very likely to remain range-bound from 1,260 to 1,370 through summer and won’t start to make its run to 1,450 to 1,500 until the third quarter. There are signs the market is oversold, with sentiment nearing pessimistic extremes. The AAII last week reported 24% bulls, a 20-month low. A Bloomberg survey found top investment bank strategists have cut their their allocation to stocks to March 2009 lows. And Citigroup’s panic/euphoria sentiment model dipped into panic territory last Friday, indicating a near 90% probability that the S&P is higher in six months and a 96% chance it is higher a year from now.
I traveled this past week to Texas, where I saw maybe 100 flags from that great state. I don’t even know what my Pennsylvania flag looks like. The advisors I meet in Texas are among the most friendly and proudest of their state as any I meet around the country. What does this have to do with investing? Nothing. But summer’s almost here and it’s hard to concentrate when everyone’s leaving early for the weekend and the start of summer. RBC Capital believes a trading rebound is attempting to develop, but the technical evidence supporting the bounce is not yet convincing, given that small cap and emerging market indexes are making new relative performance lows vs. the S&P. Moreover, sentiment indices such as those mentioned above are rarely good timing devices, though they do tend to be extremely helpful in defining whether investors are too bullish or bearish. Right now, sentiment is sending a warning to not become too bearish.
Dinner among EU leaders over in Brussels this past week was nothing. The 27 European leaders met for their 18th summit in more than two years of financial-crisis fighting, and in the end, agreed to meet again June 28-29. The aim of the European summit dinner was to “clear the air” and “talk growth.’’ If Greece decides to leave the eurozone, the remaining members would need to protect Spain and Italy from any fallout. That could result in a prolonged, negotiated exit, not a Lehman-like overnight surprise. In other words, not much of anything should happen for the next several weeks, or even months. Speaking of Greece, the Olympics get started in the third quarter. Past tendencies around the last six summer Olympiads show that the MSCI World Index dropped the three months preceding the games, then rose the subsequent three months (this would be in sync with my third-quarter bull-run comment above). What does that have to do with investing? Nothing, I’m just saying. With this Memorial Day weekend, I’m beginning to think about vacation … because the market is probably going nowhere for the next couple of months. So, what are you doing for the July 4 holiday?
Positives
Consumer sentiment surprises The University of Michigan’s final May consumer sentiment surprised to the upside this morning, closing at a pre-recession high of 79.3, its highest since October 2007. Consumers’ assessment of current conditions had the biggest jump, suggesting they're feeling better about their financial situation and ability to make big purchases. The gain in the expectation components was more muted but it still reached its highest level since July 2007. This bodes well for spending.
More signs of nascent housing recovery New home sales rose more than expected in April, the sixth increase in the past eight months, and existing home sales surprised, rising for the first time in three months. While still low by historical standards, new-home sales have recovered 26% from February 2011’s record low, and inventories have plunged to a 5.1-months supply at the current sales pace, vs. January 2009’s record 12.2 months. Moreover, year-over-year prices are now rising at their fastest pace since late 2006. Perhaps not coincidently, ISI Global’s proprietary homebuilders’ survey also is at a six-year high. Any non-insignificant upturn in housing is not priced into the market.
All roads lead to jobs This week’s jobless claims came in a tick below consensus, continuing their trend down to March levels after April’s spike. The May employment gauges for the New York, Philly and Richmond Fed districts reported the second best reading in the past 11 months. This looks promising as we await next Friday’s nonfarm payrolls report for May. Jobs improvement could be the catalyst for a third-quarter market surge.
Negatives
Manufacturing mo eases April durable goods disappointed, as the core declined after the prior month was revised downward. And the new Markit flash PMI slipped in May, consistent with the message of the regional Fed surveys: that the manufacturing sector appears to be showing some additional loss of momentum from April to May. However, the first month of the quarter has proven to be the weakest two thirds of the time; also, the durable goods series are notoriously volatile and prone to future revision. This isn’t worth worrying about—yet.
It’s all on Germany Markit’s preliminary composite PMI for the 17 eurozone nations fell a fourth straight month to its lowest reading since June 2009, when the eurozone was last in recession. The German Ifo business climate index fell for the first time in seven months, disappointing consensus. And first-quarter growth in the U.K. was revised lower. It isn’t so much that EU leaders are worried about Greece exiting but about the potential fallout on other EU economies if consumers and lenders react poorly. All of this is ramping up pressure on Germany, where the yields on 10-year and 30-year bunds hit record lows and a two-year note was issued with a zero coupon and at an average yield of 0.07%. Imagine having to pay for the privilege of allowing a country to run up debts, especially one that might have to eventually backstop the whole of Europe.
Three wouldn’t be a charm for Japan Fitch forecasts that the Japanese government’s debt will reach 239% of GDP by the end of the year, the highest of any of the countries rated by Fitch. This debt ratio has doubled since Q3 2000, and has been north of 200% for the past four quarters. Japan has been in a contained depression for the past two decades, and seems to be working on its third “lost decade.” Following the bursting of its real estate and stock market bubbles in the early 1990s, the government implemented numerous Keynesian-style spending programs. Meanwhile, Japan's social welfare spending rose sharply to support a rapidly aging population. Tax revenues couldn’t keep up with all the spending. The Bank of Japan enabled the fiscal excesses by adopting a zero-interest-rate policy in 1995, a policy supplemented with quantitative easing along the way. Sound familiar?
What else
Are margins signaling a slowdown? Even though Q1 surprised—with 94% of companies reporting, the S&P posted earnings per-share growth of 7.6% year-over-year vs. expectations for 1.6% growth, with sales growth nearly doubling forecasts and Q2 guidance on the rise—the percentage of S&P companies with rising earnings dropped to 64.8% after peaking at 78.8% in Q3 2011. The percentage of companies with rising earnings typically peaks about three quarters prior to a peak in margins, and eight of the 10 S&P sectors have seen margins roll over and possibly peak. Historically, the market performance fared well when the peak in margins occurred during the early stages of a bull market. However, the market has suffered double-digit losses when the market was in the late stages of a bull. Significant margin declines historically have been followed by recessions. If margins do fall and Q3 2011 is determined to be the peak, it may serve as an early indication of a slowing economy.
The most brilliant marketing gimmick, in my opinion The Street notes that some of the products that we buy without even thinking about it have the highest markups, including bottled water. Tap water costs about $0.002 a gallon (I drink from the tap); bottled water sells at around $2 for 16 ounces. You are paying for the bottle. Moreover, according to the advocacy group Food & Water Watch, more than 17 million barrels of oil are needed each year in the U.S. to make all those plastic bottles. And Columbia University says the bottled water industry has passed milk, coffee and juice in number of gallons sold, putting it behind only beer and soda. On average, Americans drink 28 gallons of bottled water a year.
Partied too hard? A study released by the National Coalition for Safer Roads indicates that Memorial Day was the No. 1 holiday weekend for running red lights last year. The reason: “Drivers may be eager to get to holiday destinations.” OK … The study gathered data from 142 areas in 18 states. If the findings were applied across the entire U.S. population, it would result in 1.2 red-light violations occurring every second, the study says. The second most dangerous holiday: Independence Day.
