Friday, January 06, 2012

The Morning Call-Employment data points to a better economy and Market

The Market

Two quiet trading days in a row. What a concept! The indices (DJIA 12415, S&P 1281) finished well within their intermediate term trading ranges (10725-12919, 1101-1372) and completed their third day in a row above the neckline (12287, 1266) of the much discussed reverse head and shoulders pattern. Barring a swift decline today, the Averages will confirm the break out above the aforementioned neckline and that should set them up for a move toward the upper boundaries of the current trading ranges.

Volume picked up a little while breadth also improved. The VIX was down again and continues to be a plus for stocks.

GLD (158) closed up and finished just fractionally below its 200 day moving average. Importantly, it did so on a day when the dollar was also up. Of late, these two have been trading inversely; and since I think that the dollar will continue to rise, that relationship has to change for GLD to advance. So yesterday was a hopeful sign.

Bottom line: stocks have rested the last two days but at levels that suggest that the next move will be up. As I discussed yesterday, I am not all that optimistic about the extent of any near term rise in prices (too many stocks hitting their Sell Half Price, Fair Value = 1336 and Europe); so I am not going to chase prices for an estimated 3-5% upside.

GLD, on the other hand, has a much better upside (potentially 25%) if it can initially get through its 200 day moving average. As I have noted earlier, our Portfolios will Add to this position if this barrier can be overcome. But to be clear, there are other significant resistance levels at higher prices, so a break of the 200 day moving average will not be the occasion to go all in.

The impact of QE’s (short):

The latest data on investor sentiment (short):



Investors started Thursday worried about news of some poor bond auctions in Europe (France and Hungary). However, that was quickly countered by some excellent on the jobs front: the ADP private payroll report pointed at higher employment while weekly jobless claims fell more than anticipated. P.S this morning’s nonfarm payroll number was also very positive.

I am actually surprised that stocks didn’t end the day on a higher note than they did. Growing employment means higher income, more spending, more savings and more tax receipts. So as employment improves, so does the overall economy. As with much of the recent data, this latest data continues to support our forecast of a recovery albeit at an historically below average secular rate. That in turn gives me confidence in the assumptions in our Valuation Model which right now has Fair Value at 1336 on the S&P.

The bad news of the day once again comes from our Dear Leader. Yesterday, He went to the Pentagon to announce a scale back in defense spending. Now I am all for lower government spending and I think that defense should share in those reductions. But defense expenditures as a percentage of total government spending has declined in recent years.

Still I have no problem with further reductions; but not at the same time that nondefense and entitlement spending are exploding. So in the sense that our tax dollars are being diverted from the common defense to (1) government sponsored interference in our daily lives via increased government regulations, (2) public bailouts of government sanctioned high risk financial enterprises and union dominated inefficient manufacturers and (3) bureaucratically determined investment in ideologically favored technologies, I believe is not only wrong in a political/social sense but also a horrible waste of the electorate’s money.

Bottom line: the US economic picture continues to improve in spite of an inept, naïve and intellectually incoherent political class. In addition, the stronger our economy becomes, the higher the likelihood that it can weather the fallout from an all but certain financial crisis that will sooner or later grip the EU. This gives me guarded confidence that August/October lows are the worse case.

On the other hand, the sorry state of both US and EU government financial policies, I believe limits any upside in equity prices until they become more responsible. Plus, given the ‘fat tail’ outcomes detailed in the Bill Gross article that I linked to yesterday, it seems (1) volatility will remain an integral ingredient of this Market, the last two days notwithstanding and (2) unlikely that stocks can surmount their late October highs [12919, 1372].

Steve Cook received his education in investments from Harvard, where he earned an MBA, New York University, where he did post graduate work in economics and financial analysis and the CFA Institute, where he earned the Chartered Financial Analysts designation in 1973. His 40 years of investment experience includes institutional portfolio management at Scudder, Stevens and Clark and Bear Stearns. Steve's goal at Strategic Stock Investments is to help other investors build wealth and benefit from the investing lessons he learned the hard way.