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Economic data shows economy still struggling

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Economic reports due out this week include new and existing housing starts, durable goods orders, and the revised estimate to Q2 2010 GDP.  Housing sales will  show about a 12% drop from June 2010 as the housing credits are now fully out of the system and natural market forces are coming back into play.  The annual unit sales rate will come in close to 5 million, the lowest since March 2009. One bright spot remaining in the economy is durable goods which should show an increase of 3% compared to June. Friday’s GDP report will show the economy grew at a  1.4% annual pace, much less than the 2.4% that was estimated just a month ago. This new information is probably the reason why Federal Reserve Chairman Ben Bernanke has stated that they will reinvest payments on their mortgage holdings back into long-term treasuries.

The economy continues to show both strengths and weaknesses, which is probably why the VIX is still elevated and the treasury yields are so low right now. People are confused and the conflicting data isn’t helping to ease their fears of another drop in the market. Uncertainty in the economy is still a large factor and until there is clarity, there will be more volatility.

S&P 500 Q2 Sales and Earnings

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As a follow-up to my post from a couple of weeks ago I want to update you on Q2 2010 S&P 500 earnings season. As you can see in the chart below, the sales and income growth are consistent with what we saw in my earlier post.  Sales growth is a healthy 9.14% and earnings growth is a stellar 41.81%.  Companies are doing better than a year ago, but are still holding back on expenditures and hiring.  As we move into Q3 it will be harder to have such impressive growth unless we get some certainty in the economy.

Advance estimate for Q2 2010 GDP due out this Friday

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On Friday July 30th the 1st estimate for GDP for the second quarter will be released by the government.  Economists are estimating growth of 2.5% with a range of 1.00% to 4.00%.  This follows the first quarter growth of 2.7% and Q4 2009 GDP of 5.6%.  The economy continues to be sluggish overall and most of the data has been mixed.  Housing, jobs, and consumer confidence have weighed on the economy, but corporate profits and manufacturing have been positive.  We have left the abyss of 2008-9 behind us and the economy has stabilized.  Unfortunately the high growth  that usually occurs after a recession has not materialized yet.  I don’t think we are in store for a double dip recession, but it is very clear that there is a lot of pessimism both in the market and in the consumer.

In addition to the GDP numbers many other economic indicators are due out this week including:

  • CaseShiller Home Prices
  • Richmond Fed Manufacturing Index
  • Consumer Confidence
  • Durable Good Orders
  • Fed’s Beige Book

And if that isn’t enough for you… The commerce department will also be releasing their annual revision to growth figures over the last three years, which might cause even more volatility in the markets if revisions are negative. It should be an interesting week that will hopefully clear out some of the uncertainty in the market, whether good or bad.

Marcus Green

Summary of Q2 2010 S&P 500 earnings

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July 12th kicked off Q2 2010 earnings season and I wanted to share some brief information and statistics of the earnings reported so far. Earnings season can prove to be a very volatile time depending on how investors read the data. Many times the market will run-up during announcements and then fall back down to where it was once the hype is over. Investors need to be careful when looking at headline numbers on TV and to always put the numbers and stock price in perspective. Just like most economic data, earnings numbers are old and the market likes to look out 3-6 months. Many times it’s not even about the earnings, but what the CEO or CFO have to say about future quarters. Also, keep in mind that the earnings reported are quarterly, year over year comparisons. Remember how bad things were back in Q2 2009? Now that I have all that out let’s get to the statistics.

Only 15% of companies have reported earnings(75 of the 497) and a large amount of those have been Financials(28%), Information Technology(19%), and Consumer Discretionary(13%). These sectors were beat up last year and although the rebound is expected, it’s nice to see them recovering. Many sectors such as Health Care, Telecom, Consumer Staples, Energy, and Materials have not had many companies report yet, but I think the trend will be about the same.

Overall, we’re off to a great start with total sales growth of 9.41% and earnings growth of 58.83%. Earnings continue to be great as most companies have cut their workforce and slowed expenditures while they wait for more certainty in the economy. The sales growth rate has been getting a lot of attention in the news because it is not higher, but I don’t think 9.41% is that bad. Companies are showing signs of increased sales, but just not as much as some were hoping. As we continue to see earnings over the next few weeks I will update you on where they stand.

Marcus Green

Protect Your Portfolio with Leverage

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Leverage is often used to increase returns, but when used properly, leverage can add protection to your portfolio.  Click below to view our Prezi presentation.

Vodia Capital: Protect Your Portfolio with Leverage on Prezi

Volatility Reigns for Summer 2010

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Precious Metals in the Silver Lining

On this Independence Day, when Americans headed to the ponds, lakes, oceans and mountains in search of ways to celebrate, the mood of the economy and financial markets was far from celebratory. In summary, we again have had another “worst.” This time it was the worst May since 1962 with an overall decline year to date of -6.65% and a decline of -14% from the S&P500’s high for the year. In a year that was supposed to continue the march of “return to even” from the lows of 2008, we are again faced with the prospect of a losing market.

Fortunately, the story is far more mixed than the pessimism currently portrays. For each of the negative economic data hitting the headlines there is a very distinct and measurable silver lining, most easily seen in the housing and employment figures.

Housing starts for June were 593,000, down 60% from their peak in 2007: This is an abysmal figure, indicating the lack of jobs in construction and all the consumer markets that go along with new homes. Yet this level is not sustainable long-term. To accommodate population growth and regular demolition of existing homes, we need a rate of roughly 1,500,000 starts. At the current level, we will be facing a housing shortage at some point. When and how that unfolds is debatable. Yet housing will see a strong rebound based on the basics of supply and demand providing relief to the largest and most depressed asset class for Americans.

Employment levels, at 58.5%, are at their lowest level in 25 years and declining: The lasting effects on America will be profound. (Note we are using employment statistics, which are far more reliable than unemployment reporting). The last time we saw these levels of employment, women had far fewer options in the workplace leading to a lower structural full employment level. Today, more women than men are employed. America has changed – and it will take at least a decade for the new dynamic to be fully absorbed.

The silver lining to the employment figures is corporate profitability. Companies are leaner, more able to survive on a lower revenue base and poised for tremendous profitability as the economy eases out of the recession. Companies have also been accumulating cash at startling proportions. Whether it is Apple and their $30B hoard or GE’s $70B, firms are finding ways to become self-sustaining in the face of an uncertain market. As long as one chooses wisely and is accepting of elevated volatility, this all points to some potentially strong equity returns on individual firms in the near term.

Elevated Volatility

The reality of the current stock market is that these are pretty decent levels to be investing in stocks. Companies such as Alcoa trade at one-fourth of their pre-crash market value despite profit margins that are better than ever. For Alcoa we now need for aluminum demand to increase – a forecast that changes daily with government policies from China to Australia.

The issue at hand is volatility. With volatility comes fear. And with fear comes risk aversion. The flash crash of May 6 was a rude awakening to many. The collapse of the value of BP has sent shock-waves throughout the global markets. Economic headlines are touting the risks of further collapse (I read one recent prediction for Dow 900 – that’s not a typo). Europe is a mess. The news has generated a self-fulfilling feedback loop of volatility and decline. Until these markets settle, it is possible that we will see another 10% drop or more in the S&P 500.

A very simple explanation for this volatility is a lack of buyers. In any market, there must be depth of both buyers and sellers to support asset levels. As I talk with institutional money managers around the US, the plan is the same: accumulate cash and wait for the volatility to decline. Recent headlines echo this sentiment. If the long-term buyers are not buying, then that leaves the short-term and high-frequency traders to dominate the daily trading volume. Quick in, quicker out.

While this trend will eventually revert back to the norm, with long-term buyers investing back into the equity markets, it could be weeks or months until we see it happen on a sustained basis.

Investment Direction

We have peaked in our cash accumulation. We sold off half the equity exposure early in the year and allowed cash to accumulate from bond maturities and calls. With an overweight of bonds for the year, upwards of 50% in many cases, our income has remained stable and mitigated any volatility in the portfolio from our equity exposure.

This posture, however, is temporary. While it is a nice thought to sit in cash and bonds for the rest of the year it does expose us to the risk of missing out on a substantial economic recovery. Additionally, a recovery would lead to higher inflation and rising interest rates, which would erode the value of a cash position and depress bond prices.

We will be reinvesting some of the cash this quarter in a few select companies. Characteristics that we are looking for are a strong long-term valuation, a solid cash flow base, significant dividend payments, and balance sheet stability.

Beyond individual firms, we will also be reintroducing exposure to emerging markets. Specifically, we have highlighted Asia as our primary investment focus on an international basis. This deliberately ignores Europe for a host of reasons related to growth, veers away from Latin America (at least temporarily) because of their heavy reliance on commodity prices, and India (namely due to a lack of understanding of the social situation).

Within Asia, we look at countries that will benefit from the rise of China while avoiding their inherent politic uncertainties. Namely, South Korea and Thailand are both in our short-term highlights for reasons unique to each (we will have further research available on each country). To augment the country exposure, we will also incorporate additional commodity exposures to capture the move to electric production and other infrastructure trends as China attempts to urbanize the population at a rate that is equivalent to building two New York Cities each year. The lone cost of replicating the Yankees may bankrupt that trend…

Hope everyone is able to stay cool in this heat, or has found a nice escape.

Regards,

David B. Matias, CPA

Down for the Year

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The last 14 months have been all about economic recovery and the tremendous gains seen in the stock market. Yet this afternoon we are down 3% on the year after a 4% decline this afternoon. Just two weeks ago, the day before the “flash crash of 2010” we were up 5%, and saw a high for the year on April 23 (up 10% for the year).

So what gives? Once again, volatility reigns. Interestingly, on the day of the flash crash the S&P500 reached a low point of 1065, just 1% away from where we stand today. While the market mechanisms on the day clearly failed with some stocks trading at a penny, the overall level was not a mistake. This is where the market was headed, and the panic of electronic trading run amuck was just a diversion.

I don’t have any remarkable insight into the market volatility over the past two weeks, other than to reiterate our view that the equity markets were far too complacent. Despite a balance of news this week, some good and some bad, nothing was going to keep equities from falling. In many ways, this is a sentimental sell-off after another short-term bubble.

How are things different from the collapse of 2008?

  • Companies are already trading at low stock prices to their absolute highs. GE is trading at 1/3rd of its peak. Citigroup is 1/10th of their peak. Both have dramatically cut or eliminated dividends.
  • Companies have finished cutting jobs. Manufacturing has stabilized, people have cut back on their spending and debt levels are going down in the US (I don’t think we can say the same about Europe, however).
  • Other asset classes are reacting well. Government bonds are up. Corporate bond spreads have widened, but not significantly. Gold is stable, yet oil has shown some declines. Municipal bonds are up and utility stocks are flat.

There is clearly a set of economic unknowns around Europe and their debt levels, which could impact the US. That has got to be worked out over time with the corresponding impact known later. In a worst case scenario, the EU may have to drop the single currency. More likely, some of the EU “states” will have to rework their sovereign debt with a corresponding impact on the debt holders. But as far as we can see today, we are not revisiting the Armageddon scenario of 2008.

From an investments perspective, anyone who’s spoken to me in the last year has heard one mantra from me: bonds. This is why we use them, for their stability in these scenarios. We have maintained a highly underweight equity exposure, and been hording cash for the past two months. There will be a time to buy. Until then, it is wait and learn.

Regards,

David B. Matias, CPA