Volatility creates Risk and Reward
07/15/07
On Tuesday there was lots of noise about subprime problems and worries about the health of the consumer. The Dow Jones lost 148 points and no one dared to buy it. On top of Alcoa's disappointing sales figures Monday night, retailers Home Depot and Sears opened the day with ugly earnings warnings while homebuilder D.R. Horton said third-quarter home orders tumbled 47%, forecast a net loss and said market conditions continue to deteriorate. Based on this type of news the marekts concluded (prematurely as it turned out) that the American consumption machine had finally come to a halt and that the weakening housing market had finally caught up with Mr. and Mrs. America. But as is often the case, the big news that two high profile retailers admitted to having problems turned out to be the culmination at the end of a much anticipated move, not the beginning of a move. Wednesday, stocks stabilized and on Thursday, the market exploded to the upside, pushing the Dow Jones Industruials to a new all time high. The average American consumer is not dead, continues to be employed and is able to afford a decent lifestyle. Most headlines were proclaiming that sub-prime mortgage problems would turn from a portfolio event to an economic event. This has not come true yet and may not come true at all. Lets look at the charts:
Retailers overcame the low bar set for sales in June, eking out a modest performance but falling short of their gains last year. Major chain stores reported a collective 2.4% increase in same-store sales, or sales at stores open at least a year. That was better than the gain of 1.8% that analysts polled by Thomson Financial expected. But excluding a better-than-expected showing from industry giant Wal-Mart the comparison wasn't as favorable. The same-store sales growth excluding Wal-Mart also was 2.4%, short of analysts' expectation for a 2.6% increase. Consumers may have become cautious, but they certainly are not retrenching. This is also borne out by the unemployment rate, which has continued to decline throughout the year. Employers are hiring and they provide consumers with the cash and the confidence to spend. An interesting aspect of the most recent payroll report is a gauge that tells us the percentage of industries that added workers during the month: the diffusion index. In June, it was very high at 62.9% among the 278 industries surveyed, compared to the average reading of 55% or so. If June's diffusion index indicates a new trend, it would suggest that hiring trends are broadening out. At the very least, it shows that hiring is not likely to drop off suddenly. As long as employers show the confidence to hire, the consumer will show the confidence to spend. Yes, I think it is that simple. Availability of jobs is what drives perceptions and spending habits. You know what they say: If your neighbor loses his job, it’s a recession. If you lose your job, it’s a depression. I feel that it is most important for the stock and bond markets that the credit markets are not seizing up. Economic data are secondary. This week's buyout news was positive as was news on the economy and mortgage markets recovered some composure indicating that the credit markets are holding up, despite obvious strains in the weakest tier of the market. It has only been a couple of weeks, of course, so the jury is still out, but I believe that for the moment at least, the animal spirits are alive and well.
U.S. Treasury Secretary Hank Paulson declared on a recent visit to Fortune's offices: “This is far and away the strongest global economy I've seen in my business lifetime.”
The table above shows how this synchronized global expansion has translated into stock markets gains on different continents. For the past 3 and 12 months as well as for the past 3, 5 and 10 year periods, Latin America has been the clear winner. No other continent has performed better than the countries south of Mexico. This may not be the case because the countries managed their economies better than the rest of us nor can this be solely the result of owning raw materials alone. I believe that Latin America had been shunned by investors throughout the world for so long, that armageddon was discounted in virtually all of their stock markets. The return to a more normal environment where corporate assets can fetch regular bids and offers on a continuing basis is often enough to unlock significant value. It is interesting that Asia and the Asian Tigers have captured everybody’s fancy, but that the crown belongs to Latin America. The North American Free Trade Agreement (NAFTA) has contributed mightily to this development and everybody is still waiting for Ross Perot’s giant sucking sound, which in 1994 was supposed to suck all the high paying jobs away from the US. There are those now that pretend they are hearing that same giant sucking sound coming out of China. I wonder how long it is going to take for those people to realize that just like NAFTA was good for American jobs and American consumers, China’s relationship with the US has been helping, not hurting the US. Let’s hope our representatives in Washington have the ability to learn. The recent stock market rally is proof positive that free global trade is working for the US and its trade partners around the world. Volatility has increased but last week only the true believers were rewarded.
Hermann Vohs
Hermann Vohs is president of Cales Investments, Inc., a registered Broker-Dealer. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. Hermann Vohs and/or the staff at Cales Investments, inc. may or may not have investments in any of the markets cited above. Hermann Vohs can be reached at 303-765-5600.
This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities.
