Market Commentary

Stocks came under some much needed profit taking
October 21, 2009

Stocks came under some much needed profit taking after a disappointing report on housing starts and falling oil prices.  These events could not overshadow the better than expected earnings from several high profile companies.

Speaking of profits and as expected, earnings are exceeding expectations.  As per Bloomberg, 79% of the 103 S & P 500 companies that have posted results have surpassed analyst projections. During the second quarter more than 72% beat the average estimate, matching the highest proportion since the inception of this data point in 1993.

What are potential catalysts that can propel stocks even higher?  Like most I believe the averages could undergo some much needed profit taking, perhaps declining by 5%-7%.  However rarely does the consensus view materialize.

Latest data suggests there is $3.56 trillion in mutual fund money market accounts, down from a record $4 trillion in March.  The vast majority of this decline in money funds was the result of retail investors purchasing corporate debt at a rate of 16 to 1 as per CNBC.

As noted in prior remarks it appears there is a major difference regarding the direction of the economy between the markets and the analyst/media community.  What is the odds growth will greatly exceed the consensus view as suggested by equities?

It is common wisdom the retail investor is traditionally wrong, making investing decisions based upon headlines. However these headlines are the result of yesterday’s actions or inactions.  There is little forward looking thinking.

As widely known banks are minting money with the slope of the yield curve.  Essentially banks are borrowing money at 0.25% and lending it to the government at 4%.  The last time the yield curve was this steep was at the end of the last banking crisis in 1991 where over 1900 banks failed from 1987-1991.  I think it is noteworthy 534 banks failed in 1989, the peak of the crisis. 

Year to date 99 banks have failed versus 25 failures in 2008.  The number of “troubled institutions” has risen to 416 as of October 16. 

What are the odds the rally will continue with financials still leading the advance?  If history were to repeat itself, this thought is not ludicrous.  The financials led the 1991 bull market partially the result of the steeply sloped yield curve that permitted banks to quickly recapitalize.   Community banks defined as banks from $100 million to $10 billion crushed their large cap brethren advancing about 600% from their 1991 lows in about 3 years. 

I am strong believer things are never different, there are just different people.  Those who do not study history are apt to repeat similar mistakes. 

What will occur today?  The Fed’s Beige Book is released at 2:00 P.M., the statistical report that is published two weeks before a FOMC meeting.

Last night the foreign markets were down. London was down 0.90%, Paris down 1.17% and Frankfurt down 0.81%.  Japan was down 0.03% and Hang Sang down 0.30%.

The Dow should open moderately lower as some are questioning the sustainability and strength of the recovery.  Moreover some are questioning whether or not earnings estimates were too pessimistic.  I ask was this pessimism expected given the events of the last 12 months where the unexpected occurred?  Can we a case employment assumptions  The 10-year is down 8/32 to yield 3.37%.