Market Commentary

Bearishness appears to be the universal outlook
July 07, 2010

Bearishness appears to be the universal outlook, the result of weaker than expected data, a 15%-20% plunge in the respective indices since April, tremendous volatility, and multigenerational low treasury yields. 

The prevailing consensus is that the Federal Reserve has little ammunition remaining to re accelerate the economy.  Monetary policy is maxed out with the federal funds rate target at close to zero unless the Federal Reserve revives its asset purchase programs.  Fiscal policy has little maneuverability.  Regarding trade, the dollar is more likely to appreciate than depreciate.

However as the hallmark of this crisis, expect the unexpected.  As written many times, valuations are compelling.  As of last night, the S & P is trading at 11.4x expected profits.  As per Bloomberg during the first quarter the proportion of S & P 500 companies raising their profit outlook was 8.6%, the second highest level of companies increasing projections since 2001.  The number of firms reducing outlook fell to 3.4%.

The last time the spread was wider was the first quarter of 2004 when earnings began fourteen consecutive quarters of growth.  As widely known earnings then declined for a record two years, ending the fourth quarter of 2009. [Bloomberg]

Wall Street has a habit of overestimating/underestimating earning.  Again referencing Bloomberg, between the third quarter of 2007 and the end of 2008, Wall Street overestimated profits by 13%.  Bullishness was rampant believing the subprime issues were “contained.”  Since the winter of 2009, analysts consistently under estimated earnings as bearishness was/is the prevailing outlook for the well known reasons.

Most have dismissed 2010 GDP growth projection of 3.2% as unrealistic.  As noted several times this is the greatest annual growth rate since 2004.  2011 economists are expecting a 2.9% gain in GDP.

It is human nature to extrapolate yesterday’s action into tomorrow.  In my view a dichotomy has evolved.  Either today is a phenomenal opportunity or analysts have it wrong.  I believe the former.

In this vain I would like to suggest three events that might occur under the guise of expecting the unexpected.  All three are equity positive.  First, the anti incumbency mood of the electorate radically alters the power structure in Washington.  I believe the odds are around 50%.

Second, President Obama does not abolish President Bush’s tax structure at year end, however renames it The Obama Stimulus Plan. The odds of this occurring are around 20%.  Incidentally as per some wire reports, trial balloons are again surfacing in Washington that such a proposal is again being considered.

Third, a new home shortage evolves the result of lack of inventory and virtually no new home construction.  As noted several times the number of new homes available for sale are a record low [circa 1970]...213,000 yet the population has risen by 50% from 200 million to 300 million in this 40 year period.  Moreover and as noted many times approximately 1.5 million homes need to be started annually to meet normal demand.  Starts have been below this number since December 2006 and have averaged 641,000 since the housing crisis became catastrophic in June 2008.  The odds of this occurring…10%?

Rarely does the consensus occur in the economy.  If it does, all would be famously wealthy.

Commenting briefly about yesterday’s market action, equities ended moderately higher rising off of 10 month lows amid speculation earnings will support current valuations

Last night the foreign markets were down. London was down 0.70%, Paris down 0.85% and Frankfurt down 0.67%.  Japan was down 0.63% and Hang Sang down 1.13%.

The Dow should open nominally lower on concerns that the economic recovery has peaked. The 10-year is up 4/32 to yield 2.92%.