Trade Balance Starts Helping Soon
07/15/09
Chart technicians discussed the head-and-shoulders topping pattern in the S&P 500 ad nauseam this past three weeks. Some say it was a little too obvious, and there is a question about at what point the pattern is negated, but there is no question that "technically" the market was in precarious shape a week ago. We hadn't quite broken down, but we were teetering on the edge of the abyss. Things look much different today as we have ramped higher and moved back to key resistance areas around 940 on the S&P. Does this mean the head and shoulders pattern is negated? In my mind this would be the case only if we close above 950 several days in a row. At this point in time, I am not betting against the bulls, though. Mutual Funds, hedge funds and individual investors are still underinvested and they are scrambling - again - to gain exposure to stocks. It all began Monday morning, when the most bearish bank analyst around shook the market out of its lethargy. Meredith Whitney has been the hottest hand for the past few years and unbelievably correct in her bearish stance on the financial sector. With her upgrade of Goldman Sachs and a slightly more positive assessment of the banking sector, she effectively moved the market. Of course, Mrs. Whitney did not turn on a dime. While she feels that the recent "mother of all refinancing" binges will allow many banks to do better this quarter, she emphasized this is a trading call and that she ultimately expects unemployment to reach 13%. Let's look at some economic stats that are getting better.
The US non-manufacturing ISM (Institute of Supply Management), reported yesterday, was 47 in June, well above expectations and the highest level since Lehman's failure. The details were particularly encouraging as most of the sub-index readings have recovered their post-Lehman slide. Particularly the rise in new export orders to 54.5 from 47.0, which is the highest since Bear Stearn's demise, gives hope for further improvements in the economy. Business activity rose to 49.7 from 42.3 and new orders rose to 48.6 from 44.4. In the non-manufacturing ISM, six industries showed growth in June-- the top four were real estate, rental and leasing, construction, finance and insurance. The new orders index rose to a post-Lehman high and is probing expansionary territory, indicating companies are regaining some confidence in final demand. The non-manufacturing PMI bottomed before the manufacturing PMI, which is also what happened in the last recession. Now, if manufacturing orders could expand also, we may have a shot at creating jobs in the manufacturing sector within a year or so. But I am daydreaming. So far, we have an expanding order book in the non-manufacturing sector and a stable order book in the manufacturing sector. Let's be grateful for that. Back in late April, amid rampant pessimism about the economy, the Economic Cycle Research Institute (ECRI) predicted that the recession would end this summer. Anirvan Banerji said in a recent article: "In fact, the cyclical improvement in the economy is proceeding in a textbook sequence, from long leading indicators to short leading indicators to coincident indicators. In essence, there are now pronounced, pervasive and persistent upturns in a succession of leading indices of economic revival." That is good to hear. Meanwhile, earnings season started in earnest this week. So far, with about 40 of the S&P 500 companies reporting, the ratio of upside surprises to downside surprises seems to be 4:1 in favor of the upside surprises. US Managers know how to cut costs in an unforgiving environment - cost cutting of course being a euphemism for laying off people. Nevertheless, if companies start making money again, they are no longer forced to reduce head counts. Once this endless parade of layoffs finally has subsided, everybody can begin to calculate a new base line from which to calculate growth from. From that new baseline then, one can plot a way towards profitability. CEO business confidence incidentally increased to 55 in the second quarter from 30 in the first quarter. The cycle low for the index is 24. Asha Bangalore from Northern Trust says that there is a positive correlation between the CEO confidence index and capital spending. Based on his research, capital spending most likely posted its worst performance in the first quarter of 2009. This may be confirmed in future months by the ISM data above. Manufacturing then should benefit, too.
The May trade data improved to a deficit of $26 billion. Exports were up a bit and imports down, so the net is a slight boost to second-quarter gross domestic product. The Commerce Department said Friday the deficit narrowed to $26 billion, a drop of 9.8 percent from April and the lowest level since November 1999. Economists expected the deficit to widen to $30.2 billion in May. Even though exports of goods and services rose 1.6 percent to $123.3 billion in May, they are still 25% lower than in 2008. The deficit with Japan sank to its lowest level in 15 years. Imports edged down 0.6 percent to $123.3 billion, the 10th consecutive monthly decline. Imports are 34.9 % below the high of 2008. One factor reducing the trade deficit for the last 12 months was the dramatic fall in energy prices and reduced consumer demand for cheap overseas goods. The two charts above show you how the US consumer (and oil prices) turned on a dime within a quarter or two. In our November newsletter "Adjustment of Imbalances" I had written that a 5% savings rate in this $14 trillion economy would amount to at least $700 billion in personal savings/consumption reduction before the international adjustment process could slow down. Ladies and gentlemen, we can slow down now. It took the US consumer less than a year to forego $700 billion in consumption and to surpass my savings rate target of 5%. Nothing gradual about this adjustment process, as the charts above show us. Michael Darda, economist at MKM Partners, believes that the bulk of the adjustment in the savings rate has already occurred based on "historical relationships among wealth, income and savings." I share his sentiment. The US consumer was scared into building reserves, which was a good thing. I expect that the savings rate will continue to grow in future quarters, but at a slower pace. More and more funds for delayed purchases should therefore become available throughout the rest of this year. Rumors of the US consumer's demise may have been greatly exaggerated.
Hermann Vohs
"Unfortunately, the balance of nature decrees that a super-abundance of dreams is paid for by a growing potential for nightmares."
Peter Ustinov
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.
