TSG Stock Market Letter

Week Ending July 17, 2009

Topics Discussed This Week:

Best week since March 13

New Feature – Market at a glance

Earnings hang in, PEs rise

Some potentially good news on the housing front but…

Foreign purchases of U.S Treasuries still dropping

Then and now – what a difference 2 years make

Last Week

Quote of the week

“Over the course of 600 years, five dynasties had implemented paper money and all five made frequent use of the printing press to solve problems. Economic catastrophe and political chaos inevitably followed.” — Ralph Foster from his latest book, Fiat Paper Money: The History and Evolution of our Currency.

Best week for stocks since March 13

The many bearish head & shoulders patterns we discussed last week were blown to smithereens this week as stocks powered higher. It was the best week for the S&P500 since March 13, the week after this current rally began.

Why? Earnings are one reason. Goldman Sachs earnings have given investors renewed hope that the worst is over. There is growing evidence that the more than $13 trillion in stimulus programs (members of congress have been directed to use the word “recovery” instead of “stimulus” according to Barney Frank (D)) committed to by the federal government and Federal Reserve is having a cumulative impact on stocks as well as certain aspects of the economy.  But it’s far from all clear which we discuss in our Synopsis…

Market at a Glance

We begin a new feature this week designed to provide a quick market assessment. Instead of describing what happened in various markets each week, we have put them in a table. Let us know how you like it. In the last column, the trend is described as bullish if positive for the overall market or bearish if a negative. (MA in the fourth column stands for moving average.)

* 52-Week High / Low

†LIBOR is the benchmark for $900 billion in subprime mortgage loans which typically adjust to it every six months. Corporations around the world have the interest rates on roughly $9 trillion in debt pegged to LIBOR and rates on more than $380 trillion in derivative interest rate swaps also are based on LIBOR. About 6 million U.S. mortgages, including the vast majority of subprime home loans as well as 41% of prime ARMs are linked to LIBOR.

Earnings hang in, but PEs on the rise again

This week, earnings for the 8,011 US stocks of the VectorVest Composite Index (VVC) held steady at an average $0.16/share from $0.13/share two weeks ago. However, rising stock prices lifted the VVC average PE to 125.4 this week from 118.42 last week. June 5, 2009 proved the all-time high water market for average PEs at 155.58 for the VVC Index with average earnings of $0.13/share. However, earnings growth, which tells us how fast earnings are appreciating, remained stuck on the floor at 1% again this week, which is the lowest growth rate in at least 15 years.  On the positive side, the VVC decisively broke above the 50-week moving average (purple line in next chart) this week for the first time since the rally began.

These recent all-time highs compare to the previous peak PE of 60.51 in mid-May 2003 during the last recovery. But the difference is that during that period, earnings growth remained much healthier at 8% and earnings had begun improving nearly a year prior after hitting a low of 3%. Looking back to the price peaks in March 2000, average PEs were 32 and earnings growth was 11%. 

Figure 2 – Chart showing weekly prices, average Price/Earnings ratios (blue), earnings per share (black) and earnings growth (GRT in red) for 8,011 US stocks tracked by VectorVest showing the average PE for the broad range of publicly trading companies. The purple line is the 50-week moving average (MA). Chart courtesy of VectorVest.com

Meanwhile average earnings for the 2,969 stocks in the Canadian Toronto Stock Exchange (TSX) tracked by VectorVest held again at -$0.01 up from -$0.03/share two weeks ago.

Earnings for the nearly 3,000 stocks of the VectorVest Canadian Index (VVC/CA) peaked at an average $0.73 per share in September 2005 and have steadily fallen since. By the week of March 6, 2009 they had fallen to $0.16/share and on June 12 to -$0.02/share during a period in which the TSX exchange index rose more than 40%. 

Economic Reports

CPI – Are we really in a deflationary period?

For what it’s worth, the official consumer price index (CPI) jumped 0.7% in June, up from a 0.1% rise in May. On an annual basis, the CPI declined 1.4% from last year. But calculated the way it was before the many changes were instituted by the Clinton Administration the latest alternate annual CPI was 6.05% in June versus June 2008 down marginally from the annual rate of 6.15% in May according to ShadowsStats.com. We refer to this number as the real inflation rate.

So while the official CPI is showing deflation, the real CPI shows inflation north of 6%.  Why is this important? One of the best defensive strategies for a deflationary environment is to hold cash. But this is about the worst approach during inflationary periods. At the current real inflation rate, dollars earning a low or zero rate of return are actually losing value. More about this in our upcoming ProfitScore IQ monthly report…  

Some better news on housing front but…

We got some better news on the housing front this week with the release of two reports. First we learned that the National Association of Home Builder housing market index ticked up to 17 from 15 last month as builders got more optimistic about the new housing market. It was the highest reading since the index hit 17 last September.  .

And the latest data from the Census Bureau on building permits and starts showed that builders are putting their money where their sentiment is. Permits jumped 8.7% in June (from May) to 563,000 units while starts gained 3.7% to 582,000 in June. Next week we see how new home sales have responded. In May, there were 342,000 new homes sold, down 0.6% from April showing the builders continue to add inventory to the more than 10 months supply currently. 

But we did get one bit of bad housing news. According to RealtyTrac, foreclosure activity in the U.S. rose to another new all-time high as a total of 1,905, 723 foreclosure files were reported on 1,528,364 U.S. properties for the first six months of 2009. This was in spite of the industry-wide moratorium earlier this year, legislative action at the local, state and federal level as well as significant loan modifications by lenders, according to RealtyTrac CEO, James Saccacio.

A total of 336,173 foreclosure files were reported in June, for the fourth straight monthly total exceeding 300,000. A total of 889,829 foreclosure filing were reported in Q2-09, up 11% from Q1-09 and up 20% from Q2-08 with the highest foreclosure filings being reported in Nevada, Arizona and Florida. This means that buyers looking for bargains will continue to have an increasing number of bargains from which to choose in the coming months, further depressing new and non-distress home sales.

Foreign purchases of U.S Treasuries still dropping

Monthly net Treasury international capital flows which is the net amount of purchases of long-term and short-term Treasuries by foreigners fell again in May by $66 billion as foreigners continued to cash in more than they purchased, versus a net redemption of $38 billion (revised) in April according to the U.S. Treasury Department. Net foreign purchases of long-term Treasuries fell by $19.8 billion and U.S. residents purchased a net $27.7 billion in May.

Even though Treasury auctions continue to attract sufficient buyers for the time being, the net sale of long and short-term Treasuries to foreigners has been steadily dropping since 2005. Is it any wonder foreigners are losing interest? Yields for the benchmark 10-year Treasury notes rose to 3.65% this week but from a longer-term perspective, 10-year Treasuries lost 4.5% in value during the first half of 2009 for their worst performance in 30 years according to Bloomberg.

“The fall in international [U.S. Treasury] demand reinforces the fact that based on our massive borrowing needs we are very vulnerable,” Mark MacQueen, partner and portfolio manager in Austin, Texas, opined in a July 18 Bloomberg article entitled Treasuries Fall for First Time in Six Weeks.

Not only are Treasury investors losing money on a nominal basis, the current yield is more than 2.5% below the real rate of inflation – not  a situation that investors with any sense will continue to tolerate for long. 

SYNOPSIS

Then and now – what a difference 2 years make

In his July 17 Breakfast with Dave newsletter, economists David Rosenberg from Gluskin, Sheff performed an interesting comparison of some key economic and market metrics now versus then – July 2007 when the current credit crunch began to unwind. 

We summarize his list and add a few of our own.

Things have certainly changed in two short years. Metrics like total credit market and government debt, unemployment numbers, government and Federal Reserve stimulus commitments (that so far roughly equal annual U.S. GDP) and average Price/Earnings ratios have all gone through the roof while CPI (both official and real), GDP and average earnings per share have plunged. 

In July 2007 troubles had begun to emerge – Bear Stearns had already required emergency intervention to try to save it.  But two years of stimulus, a new president and more than $14 trillion later, the economy is still in a shambles.  As Dave pointed out, someone at the Fed is forecasting that the unemployment rate will hit 10.6% which is within striking distance of the 10.8% peak reached in November-December 1982.

It is an unfortunate irony that this last comparison is flawed. If we calculate the unemployment rate using the 1982 calculations, today’s unemployment rate is currently 20.6% not 9.5% which makes it a far more challenging period than the 1980s – one which more accurately rivals the 1930s during the Great Depression.

It is another example of why relying on current government stats can be hazardous to your financial health. But no matter which data upon which you rely, the world we live in today is very much different than it was two summers ago.

Elliott Wave Perspective

Last week we showed a Zigzag in Wave A (down) with the highest probability target area lower. As it turns out, the SPX rallied with a vengeance and in the process put in the bottom of Wave B. 

This week the highest probability pattern is still a Zigzag that looks to be in 5 Wave C that tends to be roughly equal to Wave A in price movement giving us the highest probability target area (dark gold on the vertical price axis) between 1050 and 1200. The big caveat here is that given that the index is in a corrective wave and that these waves are often very volatile, this pattern has the potential to resolve into another corrective extension in Wave B which would take the index lower. Given that summer markets have lower volumes and can therefore be more easily influenced by a few large players, caution is advised. 

Hourly chart of the S&P500 Index showing the highest probability pattern from the March 6 low.  Chart courtesy of www.elliottician.com

On the lighter side…

More market definitions…

VALUE INVESTING — The art of buying low and selling lower.

P/E RATIO — The percentage of investors wetting their pants as the market keeps crashing.

Stories of interest this week…

Obama's Cheaper Mortgages Trigger Lower FICO Scores for Payers

http://www.bloomberg.com/apps/news?pid=20601213&sid=a6kuLOY.MRMc

Foreclosure Filings in U.S. Reach Record 1.5 Million

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=afOsHVj02UMc

CIT Group’s Banks Said to Weigh Bankruptcy Financing

http://www.bloomberg.com/apps/news?pid=20601087&sid=aAxblWMCEuDg

AIG’s “Toxic” European Derivatives May Take Decades to Expire

http://www.bloomberg.com/apps/news?pid=20601109&sid=aXu5aUboayJY

Mobius Says China Market Value to Overtake U.S. in Three Years

http://www.bloomberg.com/apps/news?pid=20601087&sid=a4.VQEZdQ__M

Forecast - U.K. Economy Will Shrink 4.4% This Year

http://www.bloomberg.com/apps/news?pid=20601110&sid=aXF3Bmb.TztQ

Treasuries Fall for First Time in Six Weeks as Stocks Advance

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aVIVaL2qqOWY

Fiat Paper Money: The History and Evolution of our Currency by Ralph Foster

http://home.pacbell.net/tfdf/

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