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Market
Bottom? Maybe. Economic Bottom? Not Quite Yet. |
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After
five straight weeks of losses, this week's huge gains inspired plenty of
discussion of whether or not we've actually made 'the' big market
bottom. We'd have to agree the arguments in favor of a bottom already
being made are getting better and better every day. Are they good enough
though? We've got some detailed thoughts on the matter today.
Let us preface
the discussion by first explaining the economy and the market are not
the same thing.
Reality check...
stocks
don't always trade at what they're worth. Heck, they usually
don't trade at what they're worth.
 Stocks
are only valued appropriately about twice a year though, and we're not
just saying that for effect. The rest of the time they're undervalued
or overvalued. However, that's where the real opportunity is... in spotting
those misvaluations.
Don't hear us
wrong - a strong economy helps stocks, a lot. In fact, every
stock will eventually trade at its fundamental value, and fundamentals
are
ultimately driven by the economy. But, if you're married to the idea that
the economy needs to be 100% healthy before stocks start to gain, you're
probably
going
to miss out on a lot of any gains.
Therefore, the
market and the economy each deserve their own analysis, and any investing
decisions should stem from that dual perspective.
Due to space/time
constraints, we're going to split this edition of the newsletter into two
parts. We'll look at some economic data today, and we'll examine
the market - and its charts - in the coming week. That will also
give us a chance to gauge if this week's bulls are in the same mood next
week. The economic data won't change as quickly.
Make no mistake
though... this edition should be mentally processed side by side with
that upcoming edition.
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Indications
of Economic Improvement |
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Part of Friday's
buzz was the result of March's preliminary Michigan Sentiment Index
reading. The move from February's score of 56.3 to this month's 56.6
isn't a major lift, but as we've said before, perception is more important
than reality. If the market expected dismal numbers and they ended
up being mediocre (as they were), it's interpreted bullishly.
 That
said, we've never found this kind of sentiment data to be useful except
as a contrarian tool, when the opinion polls reach the extreme ends
of the scale. In other words, the multi-year low reading of 55.3 in January
came well after a market tumble, and right before a very
trade-worthy rebound. To see these consumers still this pessimistic hints
that stocks could climb a wall of worry.
On that note,
the Conference Board's Consumer Confidence Index reading fell 37.4
to 25.0 in January. February's numbers aren't in yet. The interpretation
is the same as with the Michigan Sentiment Index - contrarian -
but we've found the Conference Board's measure to be even easier to
read in a contrarian light.
 Citibank
probably wasn't kidding when it said it was on track for an operating profit
in Q1 of this year. The yield curve indicates that long term interest rates
are considerably higher than short term interest rates again, which is
where a bank finds profitability.... they can borrow money cheaper than
they can lend it.
Don't expect
to a bigger bottom line in terms of dollars though, as borrowing
and lending activity are both lower. But, what little lending activity
they are creating is at least profitable business.
Odds are
that most banks are experiencing the same benefit, making banking a
viable business again. It also points to at least a slight increase
in credit liquidity compared to Q4 of last year, but keep reading -
that slight increase in lending liquidity is already under pressure.
By the way,
the nearby image is pretty stark, showing how the last two inverted
yield curves did indeed occur in front of a bear market, even though
the curve 'uninverted' fairly quickly in both cases.
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Economic
Factors Still in Question |
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The bulk of
last year's economic woes were said to be caused by a freezing of the credit
market - a lack of short-term lending meant businesses were basically shut
down. And, the indications did indeed say it wasn't just a perception
problem or grumbling... credit really did freeze up.
 Specifically,
the two key indicators of lending liquidity both shot up to stifling levels
in September and October. Those two indicators are the TED spread,
and the LIBOR-OIS spread.
The TED spread
is just the difference in rates between inter-bank loans and short-term
government debt (T-bills). Or, to be more specific, the TED spread is the
difference in interest rates for 3-month T-Bills and the 3-month LIBOR
rate. The LIBOR rate (London Interbank Offered Rate) is what banks charge
each other for short-term loans. More important to us, the TED spread
measures the lending market's overall perceived credit risk....the
difference between risk-free rates and still-relatively-low-risk inter-bank
lending rates.
The LIBOR-OIS
spread is the difference between the London InterBank Offered Rate and
the Overnight Index Swap rate, or the interest rate charged for short-term
interbank loans all banks need from time to time. The LIBOR-OIS spread
is the perceived (though generally accurate) availability of funds
available for short-term loans. The lower, the better the liquidity.
The good news
is, both spreads started to fall after peaking in October, and by January
were back to tolerable levels.
 Guess
what though - both of those spreads have actually started to creep higher
since then. It's been a quiet, modest rise in both cases, but considering
credit liquidity was never fully restored, even a slight rise from
January's levels is apt to have a noticeable negative impact.
We thank Bloomberg
for the charts.
And do we
even need to mention unemployment? We're not so much concerned about
shockingly-high levels; we're more concerned about the trend. Some
investors won't be happy until unemployment is under 5.0%, but we've seen
how falling unemployment - from any level - coincides with rising
stocks.
That said, the
market is likely to start its rebound before unemployment starts
to fall. So, don't look for an early warning from the unemployment
trend. (It's a GREAT economic confirmation though.)
If lending and
borrowing really is the life blood of the economy right now, then the two
interest rate spread charts studied above are the economy's biggest liabilities
we see at this point. We'll continue to monitor both.
Other pieces
of key economic data we didn't discuss include capacity utilization, industrial
production, and any measure of retail sales or consumer spending. Of course,
this includes housing market measures.
 We
know all of those were in a downtrend through January, except 'ex-auto'
retail sales. But, given the way the Michigan Sentiment Index recovered
along with the stock market, (which is the ultimate indicator), we
don't want to jump to a conclusion about any of that economic data until
we can factor in February's and March's numbers. Why? January
and/or February may have been the pivot point.
In the coming
week we'll hear about capacity, productivity, housing starts, and building
permits.
However,
though this won't change any economic data, also bear in mind stocks
are way overbought right now (in the short term) thanks to those
magical rallies over the prior four days. So, don't be surprised to see
a little - or even a lot of - bearish pressure in the coming week
as the potential profit-takers think things through. As long as any selloff
doesn't completely unwind this week's gains, investors will probably
remain optimistic through a minor pullback.
Of course, this
also suggests you wait for a dip if you're buying in. No sense in piling
in at what's starting to look like a short-term top.
Be sure to keep
any eye out for part 2 of this edition... the 'market' portion.
It'll be published in the first half of next week. We'll look at the other
economic data in the blog.
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Updated: 8:15 pm PDT (03:15 GMT), November 2, 2010
