Bull Markets Everywhere - Why not at Home?
10/15/07
Two weeks ago we tried to explain why we thought that the American consumer is not dead. We argued that personal income has been rising faster than the cost of living increases in the areas of housing, food and energy. In the two weeks since then, the Dow Jones Industrials rose by 200 points but more importantly, the additional data that came out supported our view. The U.S. economy added 110,000 payrolls last month, and the data for July and August were revised higher. On average, economists polled by Bloomberg were looking for an increase of 100,000 jobs in September. The unemployment rate rose to 4.7% from 4.6%, as analysts expected. The real surprise, however, was the revision to August, which now shows a gain of 89,000 jobs, mostly because of the government sector. Initially, the Labor Department had said that 4,000 jobs were lost that month. For July, 93,000 workers joined payrolls, up from the 68,000 previously reported. In short, the job market stays somewhat feasible and in any event not as weak as most people had feared. The other economic news that supported our view was that retail sales exceeded the consensus forecast in September, posting a solid advance by historical standards. On a year-over-year basis, retail sales were up 5.0% through September. Excluding automobiles, retail sales are up 5.1%. Both of these figures are inflated, however, by gasoline sales, which means that sales of most goods are running below trend. Nevertheless, the sales pace is respectable enough to indicate that the consumers' spending power has not diminished. Below you can find two more reasons why the U.S. consumer refuses to quit:
Overall wages continue to increase and actually accelerate. The first picture above shows the overall compensation level of the American employee, which is released quarterly along with other GDP data. We see that the annual increase is still accelerating to the upside. From this picture we can infer that the average consumer continues to do better than ever before. "But what about inflation" you ask? The next picture shows the real weekly earnings growth of the average employee after inflation. Here we see that net earnings growth averaged 1% - 3% over the past 12 months. The other two arguments for a continued, albeit subdued economic expansion were the rising profitability enjoyed by most U.S. corporations and the fact that strong international markets continue to expand at a torrid pace. Foreigners continue to buy our goods (now more than ever) as evidenced by the latest Balance of Payments report. The U.S. trade deficit in August was $57.586 billion and came in $1.4 billion lower than expected. The trend of a declining deficit continues and now dates back about two years. This means that both outright and as a percentage of GDP, the trade deficit has been shrinking for about two years. U.S. exports have been extremely strong in recent times, which enabled the factory sector to offset to a large degree weak domestic demand. In August, U.S. exports were up 12.8% vs. a year earlier, almost double the average of the past 15 years. Strong year-over-year growth in exports has been a feature of the U.S. economy since the beginning of 2004. Since then, U.S. exports have increased an average of 12.3% per year. Remember the platform company? Those are the companies that retain all the rights to their products, perform all the advertising and marketing and selling functions every other business is performing also, except they let others do the manufacturing. Read up on this concept again. GaveKal truly was onto something when they explained it in their book "Our Brave New World" a couple of years ago. The international companies with strong name brand recognition, strong patents and strong technological advantages are exporting like crazy and making money doing it. The economic backdrop is there for stocks to go higher: Consumer income and spending patterns are constructive and exports are soaring. What about the technical picture? They are not as clear cut: All indices are overbought, investors are optimistic, both the Investors Intelligence and AAII sentiment indicators show an extremely high percentage of bulls and the Members’ Short ratio is creeping up. All those are negative indicators, but they are useless timing tools. They point to the high possibility of a correction or long-term consolidation at some point in the future. This is a normal state of affairs after a snap-back rally such as we saw since August but it does not mean that we are headed for a crash.
Despite the short term technical negatives hanging over the stock market, it seems to me that for the time being it might not be a bad idea to suspend disbelief and just keep on buying. The main reason is (the old) liquidity again.
Accelerating global and domestic growth is causing (and is caused by) rising money stocks, not only in the US but worldwide. You can see in the picture above that MZM has risen at an annualized rate of 12% and continues to accelerate. This will push all kinds of assets (including stock prices) skyward. More money chases goods and returns around the globe, causing asset values and inflation expectations to rise. Moreover the U.S. stock market as measured by the S&P 500 was the 5th worst performer of the 83 major stock markets in this world. This fact combined with the fundamental backdrop in the U.S. might actually appeal to foreigners who can buy equity exposure for a song compared to their own markets at home. In other words, U.S. stocks are cheap and become cheaper the more the dollar falls. Foreigners will warm up to our equity markets soon, if only for a trade. Another aspect of liquidity has been demonstrated quite nicely by Adam Oliensis in his most recent report. Liquidity continues to soar. The other chart above shows the Euro-Yen cross plotted against the S&P 500. Both run exactly parallel to each other. The S&P500 rises as long as the yen falls, once the yen rises, the S&P 500 falls. (Please keep in mind that a rising amount of yen per Euro equals a falling Japanese currency.) This can only mean one thing: The yen carry trade is alive and well. When our markets tanked in response to sub-prime mortgage problems, the large money pools were caught off guard and reduced their leverage by buying yen to repay their loans in Japan. Once the dust settled, they put the trade back on by selling yen and investing the money in markets with higher expected returns. Since August the yen has been falling dramatically, which also benefits the borrowers since they have to buy less yen when they want to repay the loan in Tokyo. Keep an eye on the yen, it will show you when the liquidity picture is changing. Until then it might be prudent to take profits but I sure would not want to go short in this environment.
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.
