01 Oct 2010 Indicators Are Improving

September’s gain of 8.92% (total return) for the S&P 500 index represented the largest increase for the month since 1936. The most widely used gauge of value, the price/earnings ratio shows stocks are still reasonably valued at 12.5 times projected earnings for the next 12 months. Projections are for earnings to grow 36% this year and 15% next. In the past two weeks individuals’ confidence in stocks has risen the most since March 2009, according to the American Association of Individual Investors. The March 2009 rise in sentiment preceded an 82% rise in stock values which peaked most recently in April of this year.

Yesterday, the government revised GDP growth for the second quarter for its third and final time modestly from 1.6% to 1.7%. Year-on-year, real GDP growth for the second quarter was up 3.0%, compared 2.4% growth in the first quarter. The inflation component of the report remained at 1.9% annualized. Last week, the National Bureau of Economic Research said that the longest recession of the postwar period ended in June of last year. The news did not surprise any on Wall Street, but it provided some fodder for cynical humor on Main Street. 

So how’s the economy doing as we officially begin the fourth quarter of the year? Much of the latest economic data suggests that growth continued to improve modestly in the third quarter. Today’s news that consumer spending rose more than forecast in August is perhaps the best economic news in the recent batch. The Commerce Department said that purchases rose .4% for a second month with incomes up .5% – the largest advance for the year according to Bloomberg, though a big chunk of the advance was due to government unemployment benefits.

The future for employment remains uncertain. The most sensitive indicator, Initial Jobless Claims continued its favorable trend as the four-week average of claims fell for the fifth straight week. But it takes a strong and growing economy to sustain job growth. In a paper released Monday, the Federal Reserve Bank of San Francisco warns that economic growth will be “at or below potential” levels. Slow growth will not be sufficient to generate jobs suggesting “the unemployment rate could rise by as much a 0.5 percentage point during this period,” moving from the current level of 9.6% to 10.1%. The paper’s authors, economists David Lang and Kevin Lansing, observe “such a scenario would take the unemployment rate back to the peak recorded in October 2009,” according to Bloomberg.

The housing market remains equally difficult to gauge. The somewhat dated, yet detailed data provided by S&P Case Shiller shows weakness when the data is adjusted for seasonal influences. And July is a busy time for the real estate market. Adjusted data for the composite 10 index of major cities was unchanged in July and is down .1 for the broader composite 20 index. Details show two months of price moderation following the spring stimulus surge, as reported by Bloomberg. Alternatively, the unadjusted data indicates strength with the composite 10 rising .8 for a fourth straight solid gain. But even here, the year over year rates are trending downward.

With housing, unemployment, and a bitter political environment one would expect the consumer to be completely hunkered down. The most recent Conference Board report on consumer confidence was down five points in September to 48.5, the lowest level since the beginning of the year. The high was 62.7 reached in May. However, today’s University of Michigan consumer sentiment paints a rosier picture. Their index rose during the last half of September primarily in the forward-looking components of the index.

While polling of the consumer remains mixed, the same can be said for investor polling, i.e. the bond and stock markets.  Stocks have been on a tear lately as equity investors conclude that the economy may not tank after all. But equally important is the polling data from bond investors. US Treasury bonds have not fallen dramatically in the face of an historic September rally. Moreover, in mid-September they took off again and are near mid-August highs for the 10-year bond. These investors could agree with their equity counterparts that recovery will continue or that we will drift back into recession; either way inflation is not a problem for them in the foreseeable future.

Closing Words

If you are a stock or bond trader, indeed if you buy or sell stocks for any reason other than to rebalance to a prescribed long-term model allocation, you should stop reading. The remaining message is intended for you investors who have decided to efficiently employ the capital markets as a vehicle to confidently meet or exceed your life’s important goals. For you, trading stocks or bonds offers no entertainment or commercial value. When you hear investing is like gambling in Las Vegas, you take comfort in the knowledge that you are the ‘House’ and not the guy throwing the dice.

An article in today’s Yahoo.com Finance section entitled Stocks sizzled in the third quarter, but will it last? caught my eye. It embodies the problems facing most ‘investors.’ They are caught up in the myth of ‘buying low and selling high.’ It is a winning strategy if you happen to be in the buying and selling business, you know your business very well, and you have a proven track record of profiting more times than not (after paying taxes and other costs). Problem is, too many people employ this strategy with their life savings with no certain knowledge of the future, no guarantee of profiting, and the certain guarantee of decreasing returns with higher costs and taxes. There are countless studies to show that this group of lifetime investors is no good at ‘buying low and selling high.’ The best one is the ongoing Dalbar study which shows that while the average stock fund returned 11.6% in the 20 years ended 2008, the average investor in those funds received returns of only 4.6%. The other 7% went to the ‘House.’

The article makes the point “that investors took far more money out of stock funds than they put in — more than $42 billion for the quarter and more than $15 billion in September.” Morris Mark, president of New York investment firm Mark Asset Management says that “people are not swarming back into the market, there’s a lot of money that could be invested, but it’s not happening yet.” Is it just me or does the term ‘swarming’ suggest good poor planning? At any rate, this group of ‘lifetime savers’ just missed an 11% return during the third quarter.

We help our client’s control what is controllable and plan for what is not to confidently meet those things imminently more important to them than the S&P 500 or Dow Jones – their dreams.

Have a great weekend.