It was 27 years ago last week that the market hit its bottom in the 1981-1982 bear market. That market had seen stock prices fall to rock bottom valuations and yet, no one wanted to own stocks that summer. To think, Philip Morris at 6 times earnings and yielding 8%. The environment then was horrendous. Interest rates on long-term Treasury bonds were still at 12%, down from 15% in late 1981. The prime rate had fallen to 17% from over 20%. If you wanted a mortgage loan, you had to pay 18% or better. Unemployment was over 10.5% and still rising. Business Week magazine argued that stocks were dead. That was the bottom of a life time, unless you managed to live long enough to see the low earlier this year.
So, what happened after that traumatic low? Within 12 weeks, we were vying with new all-time high prices. Of course, that was only a little over a 50% move off the bottom, but it was thrilling none the less. The market was a coiled spring ready to be released. The differences between these two markets are many, the similarities also. But, the big similarity of having absolutely horrible investor sentiment is very powerful. Even after that first huge move off the bottom, a lot of investors argued that the return of the Great Depression was just past the horizon and we’d be sorry for investing now. Yeah, we were sorry we didn’t invest even more. We still have very subdued sentiment for the market even after the huge move we’ve enjoyed these last several months. Usually, after a big move, a bunch of ‘investors’ see a good reason to join the party. Today, there is a stubborn desire to sit it out. Maybe what we’ll need is new highs before these folks get the message.
If there is one thing your pundit has learned in all the years hanging around this business is that the crowd is seldom right about anything. When you get a consensus built up over anything, that is something you can probably bet against. Stocks had nowhere to go but up in the spring of 2000. Oops. Stocks could never return to the highs of 2000. Oops, again (NASDAQ excepted). Now, the idea is that we are in a long-term bear market that has to revisit the lows of this spring. We’re guessing that another oops is in the offing.
Why could we have a major leg up from here? First and foremost, we are still cheap. That could change with a significant rise in interest rates, but we don’t foresee that quite yet. We do expect a huge improvement in earnings. We do expect to see a reduction in risk aversion as we get further away from the crucible of the March 9th lows. But, there is also a huge pile of cash, estimated to be $4 trillion-plus waiting to get back into the market. This huge pile exiting the market was a major element in getting as low as the market got. Having them try to get back in will have a commensurate positive influence, we think.
We could easily see new highs in equities once this sea of liquidity sloshes back into the market. Before all of it gets back in we will see another couple major moves upward like the one we’ve just seen from March to now. Heck, these coming waves of buying could be even bigger.
By the way, the return from August 1982 to March 2009 has been a little over 8% compounded before dividends, so probably closer to 12% all in. That is after making essentially no money in the last ten years on stocks. Not bad at all. Think what it might be over the next quarter century or so.
Good Economic News
Productivity climbed at an incredible rate in the second quarter. The gain of an annualized 6.4% was the highest since the last recession. But, this shouldn’t come as a big surprise to anyone who has seen how business operates. During good times, more workers are added, some of them work out, some don’t. When times get bad, the workers who didn’t work out so well are discharged while the better workers are initially retained. Productivity goes up by simple arithmetic, fewer workers but on average better workers making almost as much stuff. Another element is that so many financial areas have been hit during this recession. Financial productivity is hard to calculate in the best of times, but now it doesn’t matter as much as it once did.
Unit labor costs, which are inimically tied to productivity, also ‘improved’ last month by going down by 5.8%. Unit labor costs try to measure the cost of labor inputs across a broad spectrum of goods and services.
Other Economic Numbers
The budget deficit widened to -$181 billion from -$102.8 billion last year in July. And this is before we really start spending any of the stimulus funds. Huh?! Most of the decline is just lower tax receipts, though higher spending on things like unemployment insurance was a big part of it.
The Fed left their interest rate target unchanged after their two-day, quarterly meeting. The current zero to 0.25% range has now been in place for 9 months. The Fed really ought to raise rates now as opposed to waiting. The difference between 0.25% and 1.5% isn’t all that significant in economic terms. And that’s several increases the economy wouldn’t have to wade through once the increases start coming.
Retail sales fell -0.1% in July. That was unexpected since we’d been on a bit of a rebound in recent months. When we exclude auto sales from the figures, the decline was even greater, -0.6%. Even cash for clunkers couldn’t get us over the top in retail sales.
The Consumer Price Index was unchanged in July. This does not mean that no prices changed, only that the gains offset the losses or the losses offset the gains. The core CPI rose 0.1% as prices for services and many goods rose a little. Food and energy prices fell for the month.
The University of Michigan/Reuters Consumer Sentiment Index fell to 63.2 from 66.0 in July. The expectation was for a gain to 69.0. Surprise! This number likely caused our drop on Friday.
Speaking of our drop on Friday, stocks turned in a very summer performance last week, shifting on an almost daily basis based on news. The recent upward trend is still in force, but it is starting to lose momentum. One thing that increases our confidence is the recent tendency for the market to stage a late day rally most days. What that probably means more than anything else is that the brokers don’t want to go overnight net short the market. In an uptrend, you don’t want to have more shorts than longs and the easiest way to avoid that is to cover a lot of your short positions before the market closes. Most days, the opening has more to do with yesterday than today and many participants react to yesterday’s action or overnight events at the open. You might call that dumb money. Over the course of the day, the ebbs and flows are usually dictated by news and events, but the last half an hour before the close belongs to the brokers, the market makers, who can get their own trades done before the day is over. This might be called smart money.
During the down phase earlier this year, nearly every day had a downward cast during that last half hour. Now, that is more often than not an uptick. Watch this yourself if you like.
Stocks were headed for a lackluster week until Friday. Monday and Tuesday were down a little, Wednesday and Thursday were up a little more and Friday basically was the tie-breaker. So the week was down a little. The large cap indices were off less than 1%, the small caps by almost a percent-and-a-half. We saw some favorable reports from some stocks, some unfavorable reports from others. It was essentially a stand-off.
Foreign stocks did better with gains in the developed markets and essentially no change in the emerging ones. As usual, averages conceal more than they reveal, so the real story was general strength in Asia offsetting weakness in Europe and Latin America.
Foreign bond markets were helped by a falling dollar and a spate of economic numbers that leave the future of Europe up in the air. Japan announced that their economy grew in the latest quarter.
US bonds celebrated the dour consumer sentiment number on Friday which rescued the week for fixed income investors. The only unhappy bond folks were the high yield people. Treasuries, mortgages, high grade corporates and municipals all advanced, high yield didn’t.
Real estate securities gave back some of their recent gains, though certainly not all. The losses last week weren’t enough to undo even a fraction of the prior few week surge (okay, yes even a small loss was actually a fraction, but just not a significant fraction, say a quarter or a fifth).
Commodity prices also fell, which is odd in a week when the dollar also fell. Oil prices succumbed to gravity as the summer driving season has shown that inventories can rise even as gas demand wiggles upward for a while. Increased demand from emerging nations does not make up for the slack demand in most industrialized countries.
This past week there was a great loss for the musical community around the world. Les Paul passed away. Les Paul didn’t invent the modern electric guitar per se, but he essentially perfected it. Sure Fender made a small modification and so it was a little bit different. The Les Paul version of the electric guitar, with its solid base, was a major step toward enhancing the rock and roll sound. Les Paul didn’t really play rock and roll all that much. He was far more a country, jazz or blues guitarist. He and wife Mary Ford recorded 36 gold records mostly in the early to mid 50’s. But, he made modern rock and roll possible by making amplification not only possible, but required. He also invented overdubbing, where a musician plays one instrument or sings one part of a song and then plays or sings on another track and later mixes the two (or many more) tracks on the finished recording.
Karl Schroeder, RFC
Investment Advisor Representative
Schroeder Financial Services, Inc.