Experienced investors understand that markets move in cycles and the following graph will help visualize those cycles. If you can decide correctly where the market is currently, you should be able to take advantage of various investment strategies that have stood the test of time.
The following graphs illustrate the differences in various data series like inflation, GDP, and unemployment when recent methodology changes by the Ministry of Truth (MOT) are removed. We are indebted to John Williams of Shadow Government Statistics (SGS) for these charts.
While inflation appears to be moderating, the MOT's 2% data point is about 6 percentage points below the SGS calculation. Which one appears correct to your visits to the grocery store, the gas station and/or your utility bills.
Despite the MOT's assertion that the economy is in recovery, SGS continues to show the U.S. economy in a recession.
Despite the MOT's claims that the economy is recovering, the various unemployment series shown in the following chart suggests that unemployment remains high. The red line is the official seasonally adjusted U3 Series from the Bureau of Labor Statistics Table A-1 of the Household Data unemployment series which fell to 9.5% in the June 2010 report.
The U6 data is also shown in Table A-12 of the same report. U6 includes U3, plus discouraged workers, those working part time who want a full time position, plus marginally attached workers but only includes those out of work for one year. It is the broadest measure of Unemployment as defined by the MOT.
The seasonally-adjusted SGS Alternate Unemployment Rate reflects current unemployment reporting methodology adjusted for SGS-estimated long-term discouraged workers, who were defined out of official existence in 1994. John Williams' SGS alternate rate also counts those unemployed who have been out of work for two years.
The SGS unemployment rate is probably closer to reality than the MOT's U3 or U6 numbers. The following chart showing the number of people on food stamps would seem to confirm the SGS data. The chart only shows data through October 2009. In April 2010, the number was reported as 39.5 million with a prediction for over 40 million by the 4th quarter.
The key to understanding unemployment is the difference between underemployed and unemployed. The federal and state governments are paying benefits to over 10 million people in July 2010. The drop in the U3 unemployment rate in June 2010 occurred almost entirely because a large number of people were unemployed for over one year and were dropped from the data. Likewise, those out of work over two years were not counted in the official MOT numbers. Hence, we are seeing true unemployment in the 22% range ... in 1933, at the height of the depression, it was only 25%.
The markets during the first seven months of the year have basically not moved much. Since October 2008, the market has not favored quality stocks that meet CANSLIM® investment criteria. In the first six months of 2010, the screen for the Strategic Investing Conservative portfolio only found six stocks. The market is primarily a traders market of JOBS (junk off the bottom) stocks.
The chart illustrates the market as of 27 July 2010.
The daily market summary which is prepared by Strategic Investing for 27 July 2010 is shown below. A quick glance indicates that it does not show a strong market particularly in the accumulation/distribution ratings for the major indices.
Although the market is fluctuating and reacts to each piece of news both positive and negative, it does not seem to have much direction. The key factor for an recovery appears to be missing ... unemployment remains high and new jobless claims each week are about double the rate of the early part of this decade. The US dollar index appears to have peaked and now looks like it is moving lower, perhaps, in response to the Chinese downgrading US Treasuries from AAA to AA. Interest rate spreads between short and longer-term securities remain at record levels.
The Federal Reserve can only materially impact short-term rates and the following chart shows the 90 day bill rate has stabilized about at 1.4% in recent weeks.
During both the Bush and Obama administrations, the US Treasury has benefited from the perceived safe-haven status of the US dollar and the Eurozone financial crisis helped moved the interest rate on both the ten and thirty year notes lower to near all-time record low levels as shown below.
While the US economy shows some signs of stabilization ... it might just be the result of an inventory rebuilding cycle. Future earnings forecasts and fundamental economic indicators are mixed while uncertainty exists about future government policies and taxation. Even the Treasury Secretary Geithner admitted that unemployment is expected to remain high for an extended period.
The following two charts show the NASDAQ Composite and S&P 500 performance along with the Simple Timing Indicator (STI) signals since October 2009.
The real Achilles heel remains the financial sector which because of FASB 157 and "mark-to-make-believe" accounting rules is assumed by many investors to be sound. However, with "extend and pretend" loans in the commercial real estate sector being winked at by regulators and home equity loans being carried at par rather than being marked worthless, to the real world the financial sector remains a concern.
Investors and traders continue to be unconcerned about the disconnect between fundamentals and the market as shown by the VIX chart shown next.
Institutional investors continue to look with a degree of askance at the current rally. The number of "A" rated stocks in the Accumulation/Distribution ratings of the IBD 6000 from 1994 to the present are shown in the following chart. Clearly, the number of stocks under major accumulation is near record low levels despite the level of the market from a historical perspective. The second chart also shows the follow-through days as defined by Investors Business Daily® since the beginning of 2009.
Successful rallies have all been accompanies by a major increase in the number of A's. However, the current rally appears to be similar to the previous two follow-through days which have failed.
Is there a light at the end of the tunnel? Is a boom possible? Certainly, but the current mood of the Obama Administration in bashing business suggests that might be difficult.
Eventually, fundamentals win and the primary driver of market values is after-tax corporate profits, or at least, the expectation thereof. Since the drastic decline in the 4th quarter of 2008, after-tax corporate profits have been making a comeback and have returned to the level realized in 2006-2008 before the implosion as shown in the following chart. However, a large portion of the increase in corporate profits is due to accounting changes and cost-cutting measures. Moreover, top-line sales growth remains hard to find.
Corporate tax collections helped by FASB 157 do not show the same picture of health as seen in the following chart.
Forecasts of future earnings growth are also of concern. The following graph tracks each day the difference between companies issuing higher future earnings forecasts and those with lower future earnings forecasts. The data is reported each day on the NASDAQ.com website.
If the economy was moving ahead and earnings were increasing, one might expect a large upward lift in the above chart in recent months. That is not the case.
Hindered by lower tax collections from corporations and individuals, the gap between the federal government revenues and spending continues to grow. The deficit for fiscal year 2009, which ended Sept. 30, came in at a record $1.42 trillion, more than triple the record set just last year. The following chart shows the federal budget balance for each month in the 2010 fiscal year ... clearly, it is not sustainable without impacting the nation and its currency.
The US budget deficit for the first nine months of fiscal 2010 was $1.004 trillion versus $1.086 trillion last year. Higher corporate taxes and Wall Street's quick repayment of a taxpayer bailout could see the projected 2010 U.S. budget deficit fall below last year's record.
While the Eurozone problem remains, the downgrade of US Treasury debt from AAA to AA by the Chinese rating agency this month represents a changing picture for the US. If there are more downgrades of US Treasury debt by other rating agencies, the US Treasury and the Federal Reserve Bank will find it more difficult to finance US deficits.
Through the TARP program, the Federal Reserve effectively monetized all but $300 billion of the $2.4 trillion in US Treasury debt in fiscal 2009. If either China and/or Japan decide to reduce their holdings of US Treasuries, the impact upon interest rates could be detrimental to the US economy.
Both Simon Hunt and myself worry about the effect of the bursting of the China bubble. Political unrest along with workers striking throughout China shows that all might be not well in the country. Likewise, can we believe the data from China? Trying to match electricity data with GDP growth data along with the infrastructure buildup which is now largely over suggests that there is room for doubt about the China miracle continuing.
The 111th Congress will be noted for major legislation (health care, financial reform and cap & trade) that was passed and/or proposed wherein the Speaker of the House said, "We have to pass this bill so that we can find out what is in it." Now that is a great way to run a railroad! Of course, the law of unintended consequences will set in shortly and the poor taxpayer will get stuck with the bill.
The impact of future tax increases and increased regulations either through new legislation and/or the expiration of the Bush tax credits will not be conducive to business.
If the economy is moving ahead and not just in an inventory rebuilding phase, be cognizant of the freight traffic statistics ... containers, rail and over-the-road statistics. If we begin to see a downturn in this data, the certainty of a double-dip will grow.
Keep an eye on the trends in the housing market .. bankruptcy data and foreclosure trends.
Adding meaningful jobs in the private sector is the most important thing. Increasing government jobs does not help the economy in the long run. One of the problems that many corporations have is that the increased emphasis on productivity has reduced the need for people to work. As a result, those former employees have been regulated to unemployment lines.
With the population continuing to grow both in the US and around the world, the real challenge for governments is to foster an environment that will enable people to have meaningful work rather than spend time trying to overthrow the government.
The following chart suggests that the S&P 500 has made great strides since 1980 and has recovered much of the loss since the 2000 market break. After all, the S&P 500 had a 12 fold increase since 1980.
However, as my old mentors used to say, make sure that you look at the purchasing power of any currency before you get too excited. Here is the same chart measured against the price of the ultimate historical solid currency ... gold.
Since the 2000 peak, the S&P 500 has only fallen 85% ... a huge difference.
With US Treasuries suffering a downgrade and the US dollar index under pressure with major trading partners trying to find an alternative to its reserve currency status, wise investors will remain careful and look for those investments which will maintain their wealth in times of stress.
Until the private sector adds jobs and entrepreneurs are encouraged to risk capital, the future does not look bright.
Be careful and prudent.
But then - 'Tis Only My Opinion!
Fred Richards
August 1, 2010
Corruptisima republica plurimae leges. [The more corrupt a republic, the more laws.] -- Tacitus, Annals III 27
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Last updated - December 20, 2009