Market Commentary

Several weeks ago I was wrote either bond investors or stock investors have to be wrong
October 06, 2009

Several weeks ago I was wrote either bond investors or stock investors have to be wrong for both markets could not keep going up simultaneously.  The yield on the 10-year treasury is around five month lows and stock prices are around 11 month highs.

Last week it appeared as though bond investors had it correct as the data suggested the recovery might be sputtering.  Yesterday however the economic bulls got a proverbial shot in the arm when the ISM non manufacturing index, a survey representing almost 90% of the economy, rose to the highest level in a year breaking above 50.  Fifty is the level that designates either an expanding or contracting service economy. 

The 50.9 reading was greater than the consensus view of 50.0.  The new order sub index rose to the highest level since October 2007.  There was also surprising strength in employment as that index is now at the highest level since August 2008.

As inferred above, stocks rose rebounding from the first two week decline since July.  Treasuries also rose for the eighth consecutive day.

What market has it right?  Can I remotely suggest treasuries are rallying partially predicated upon the massive amount of excess bank reserves, a rally similar to the “conundrum” faced in another era?  Perhaps.

As widely written third quarter earnings season starts tomorrow.  Consensus is expecting results to decline by 22% before rebounding in the fourth quarter led by financials.

2010 results are expected rise by 26% and by 22% in 2011. Bloomberg states profits will surge by 54% in the next two years, the steepest increase since the 64% gain from 1986 to 1988. Is this realistic?

Several weeks ago I referenced a Bloomberg story stating that profit growth for 2010 is 11x times faster than the expected expansion in GDP.  This is the highest ratio in its 60 year history, vastly exceeding the average of 6.1.

Either growth estimates are too low or earnings estimates are too high.  The answer to this question will answer what market has it correct…the treasury market or equity market.

Bloomberg also states in the four quarters following the other two recessions since WWII that lasted more than a year—the 1973-1975 and 1981-1982 downturns-- growth averaged 6.2% and 7.8%, respectively.  If growth was around this level, earnings gains as relative to GDP will be considerably lower than the historical norm.

Several times I have mentioned the Zarnowitz rule that essentially states every steep downturn is proceeded by an equally strong rebound.  While I am not one who is in the “V” shape recovery camp, earnings estimates and equity direction are expecting such a rebound.  If such growth does occur yields on the 10-year could quickly catapult to 4%.

What will occur today?

Last night the foreign markets were up. London was up 1.54%, Paris up 1.40% and Frankfurt up 1.58%.  Japan was up 0.18% and Hang Sang up 1.87%.

The Dow should open moderately higher on economic optimism.  The 10-year is off 6/32 to yield 3.24%.