by Hal Eddins, Managing Director Capital Investment Council
Well, so far so good. The bottom appears to be in. The S&P 500's low of 666 (that's a bit ominous) was reached on March 6th and has seemed to be in no danger of being breached since. With a big second quarter rally in the bag and good news going forward, maybe we can put things on cruise control. Think again.
Actually, our current environment is when things get tricky. Yes, the S&P rallied almost 40% off of the bottom, but what will it do for an encore? Are the cyclical stocks really cheap at these levels or will they have another leg down? Is 4% a good yield to lock in on Ten Year U.S. Treasuries? Will the "terrific three" (RIMM, Google and Apple) continue to rack up the big gains for the NASDAQ?
The answer is that it's too early to tell, and that's where we come in. Counsel’s experience may come in handy when analyzing the mountains of data that are available today. When I got into the business 23 years ago, I could not have imagined all the data points I can currently access. Today’s problem is not a lack of data but rather deciding what's important: finding the proverbial needle in the haystack. In that vein, we continue to see positive data points. More importantly, we are seeing positive reactions to the news from stocks.
There are still impressive amounts of cash on the sidelines. That cash is likely waiting for a pullback to become invested. What happens if a pullback never comes? Remember that the strongest markets (like the bulls of 1991 and 2003) sometimes get "overbought" and stay that way. At times, markets seem to enjoy frustrating the largest number of investors possible. We think the next important big data points are occurring as we write. Second quarter earnings are coming thick and fast and the market’s reaction so far has been positive; stocks are at levels not seen since early January. A breakout above the January highs could possibly lead to higher prices in the fall, but the markets may need to churn sideways for a while longer before moving to higher levels.
In another sign that things may be getting back to normal, Goldman Sachs reported a record 2nd quarter and appears to be on track to pay out an average of $770,000 per employee in salary and bonuses. Correct me if I’m wrong, but didn’t Goldman JUST recently pay back their TARP funds? The positive side to this is that Goldman and their Wall Street sidekicks, Bank of America and JP Morgan appear to be profitable again. There is a spring in their step not seen since mid 2007 and that could bode well for the entire economy. Several of the banks reported that their TARP money has been a key in unlocking the credit markets and things are looking rosier for a change.
In addition to Santa Claus and the Easter Bunny, some fund managers still believe in decoupling. Decoupling involves the idea that the emerging markets will continue to grow….no matter what happens in developed countries like the United States and Europe.
China, in particular, is often cited as having moved beyond the influence of the United States. To put it nicely, that line of thinking may prove to be incorrect. Currently, China’s exports are 33% of their GDP. The U.S. is the end consumer for almost 20% of China’s export market. Suffice it to say; when one customer buys 1/5th of your product, you are still influenced by what that customer does. Furthermore, going back seven and half years, the Emerging World index has a correlation of 84% compared with the Developed World index, so I think emerging markets have a ways to go before they can truly ignore what goes on in the rest of the world.
I’ve written before about the excess of shopping space in the U.S. but this tidbit from “Retrofitting Suburbia” was surprising. The U.S has 20 square feet of retail space per citizen. In contrast, Canada was next on the list with only 13 square feet followed by Australia with a measly 6 square feet per person. This type of figure may help reinforce the theory of how much the U.S. consumer likely matters to Chinese output.
George Soros is one of the few “titans” of finance to make it through the credit crunch with his reputation intact. One of the many problems that occurred over the last few years was the proliferation in custom derivatives. Another problem is coming up with a simple and elegant way to explain the negative effect these instruments had on the world economy. I think I’ve found the answer. In a recent Financial Times interview, Mr. Soros summed the derivative crisis up in a nutshell: “It is like buying life insurance on someone else’s life and owning a license to kill him. CDS are instruments of destruction that ought to be outlawed.” There’s not much to add to that, thanks George.