10-31-2011 Market Commentary

By Eddie Katz

Barron’s - Sometimes, when enough folks are positioned for the world to end rapidly, the mere suggestion that it might occur gradually is enough to energize the bidders. Leaving now the question of where, with the market up huge in a month but just 2% this year, things might go from here. Perhaps counter-intuitively, similar moon-shot rallies through history have meant neither that the buying stampede would continue right away nor that it would be given back quickly. Numerous studies show that in prior such instances, stocks were flattish on average one and three months later, but higher six months hence by an above-normal amount, for what that's worth. The past week has also kept this year's summer-flop-and-autumn-pop course hewing, to a remarkable degree, to the 1998 saw-tooth pattern highlighted here last week.

The down-up-down-up moves from late July through October were quite similar in magnitude. As noted, this is an optimist's analogy, given the power of the late '90s bull and superior macro environment, which carried on for another year and a half beyond Halloween 1998. But can it be dismissed out of hand? We won't have to wait too long for some potential gut checks of this rally. This week promises important monthly economic releases on manufacturing and employment, the waning of quarter-end technical effects, and a two-day meeting by Fed policy makers, followed by a news conference. We'll be listening.

Pragmatic Capitalism – [Friday’s] GDP report was broadly better than expected.  And one of the widely celebrated components of the report was the better than expected personal consumption expenditures.  But how strong was this component in reality? When we take a step back and look at the bigger picture we can see just how weak the consumer remains. The Q3 real personal consumption expenditures came in at 2.2% year over year.  Since 1950 RPCE has averaged 3.4%.  Since 2005 it has averaged 1.5%.  Since 2000 it has averaged 2.3%.  Since 1990 it has averaged 2.8%.  And since 2008 it has averaged 0.4%.  If we put this all in picture format you can get a better gauge of the real situation.   It’s not pretty. The bottom line: we’re still in a secular weak period for the U.S. consumer as the de-leveraging continues.  Large budget deficits are playing an important role here and as long as the USA doesn’t fall for the austerity trap during the next 24 months we should see a modestly growing economy.  It’s a muddle through scenario, but thankfully, it’s not a collapsing growth scenario. As I’ve mentioned many times before, the risks are still exogenous as our weak patient heals very very slowly.

Gluskin Sheff - Keep in mind that we also just had the Bank of Japan expand its asset-buying program by 10%, the Fed is talking more and more about QE3, it looks like China is set to start easing policy and India has hinted that it will stop draining liquidity in its inflation-fighting quest, we had a ‘feel good’ Q3 GDP print in the U.S. today and a growing lineup of the GOP candidates are falling on the flat-tax bandwagon. We are also hearing that Mitt Romney is securing an ever- increasing number of critical GOP backers in his nomination bid. While we remain bearish on the economic outlook there is clearly some good news out there for the markets to grab onto for now. Many technical strategists are also suggesting that we could see a test, at a minimum, of 1,287 on the S&P 500 before the rally runs out of steam or at least meets a fresh source of resistance. That is not my call, but at this stage, these near-term market projections must be respected at the very least.

Barron’s - Our feeling is that the projections by the architects of the [European] plan for how long it will take and how robust it will prove in restoring the euro-zone invalids to some sort of halfway-decent recovery are the stuff of fantasy. An easy example of that is the notion that Greece will be able to reduce its debt burden to 120% of gross domestic product by 2020, from something like 170% now. We don't want to sound too grumpy. After all, the summit and the hearty pronunciamento issued upon its conclusion served its purpose: to light a fire under equity markets the world over, at least for a day. And just as important, we guess, it provided a political lift for Sarkozy, Merkel, and the rest of the gang, some of whom were badly in need of it. One ominous portent, as Michael Darda of MKM Partners points out, is that despite sporadic improvement, overall, the European debt market, in striking contrast to European equities, failed to respond with any vigor to the cheery message from the summit. And with the European Central Bank barred from chipping in to the stabilization fund, he fears the meeting pretty much was another case, as he puts it, of rearranging the deck chairs on the Titanic.

Gluskin Sheff - Gold once again is resuming its role as a monetary metal rather than just an asset to buy in risk-off periods as it pushes back above the $1,700 mark and is set to challenge the 50-day moving average to the high side. The last time it did that, the yellow metal ended up rallying about $400 over a three month span (other “precious” metals are also firming). The bottom line: gold has started to trade much better of late and may no longer be in a state of purgatory.

Conclusion – As stated last week, a successful Euro bailout will give this market legs to run. How far and fast remains to be determined but from our limited point of view on the subject, it still seems like this is just a plan for a plan to cure the sovereign debt problem. And until the austerity is actually implemented, you’ll have to excuse us for remaining a bit skeptical that all is well at Club Med. We’ll defer the remainder of the conclusion to Barry Ritholtz whose words perfectly sum up our thoughts. On Friday Barry stated, “The sun is shining, we were positioned correctly for the face ripper. And yet…There remains an undercurrent that should give one pause. The ripper was based on some rather ephemeral news, some bad sentiment, and too many people on the wrong side of the boat.

Consider: (1) US GDP: While the economy in Q3 grew at the fastest pace in 4Qs, it was primarily driven by Corporate spending, and household reduced savings. GDP improvement occurred despite the biggest drop in household incomes in 2 years, on top of the ongoing decline in home prices, and near rock bottom consumer confidence. Can spending drive GDP in Q4 and beyond? Is it repeatable? Hey, 2.5% is better than 1.3%, but I have my doubts that it is the start of a new trend. (2) European Debt Crisis: Can it really be that easy? Deeply indebted Europeans decide to go deeper into debt, and that somehow is a solution? These is a high probability that Greece will fall out of the Eurozone, go back on the Drachma, and start printing. A recession in Europe is a very high probability, assuming they are not in one right now. And yet, on this ephemera, we… (3) Take‘em higher boys: Hedge funds are dramatically under-performing, and it seemed to be a group decision to rally‘em hard [Thursday]. This was not based on fundamentals, but rather, something else entirely. We started with short covering, saw some under-invested hedgies pile in, then it was off to the races. (4) Breakout/New Trading Range: Last Friday’s breakout saw S&P and Dow break free of the range they had been mired in for 3 months.

The breakout seems to have stuck, and barring any catastrophic reversal, we should be in rally mode for a short while. (5) Year end rally: I have mentioned seasonality several times over the past week, and this rally seems to be running (or perhaps front running) into the best 6 months of the year. This does not mean the secular bear market is over, but it could very well clear us for a few weeks as we ‘melt up’.”

eddie