Thursday, June 10, 2010

Will the latest market correction continue?

S&P500 is down 4.5% since we labeled Bernanke as the official silencer of bad economic news. It appears that these days, no matter what Bernanke throws out there, the market has realized that a much quicker and stronger recovery was already priced in.

As we’ve mentioned a few times before, the second half of this year could be tougher than what we’ve experienced the last 12 months. Year-over-year comparisons will be much more difficult for many companies during the last six months of 2010. There are no indications of any steady top-line growth for companies across most industries. Most companies have cut their expenses to the bone, resulting in impressive margin expansion. However, we continue to believe that this cannot continue.

With the topic of sovereign debt now on the front pages worldwide, it appears that the government will find it slightly more difficult to continue its so-called stimulus programs. Thanks to those Europeans, our lawmakers may finally begin to take into consideration the long-term negative impact(s) of their programs. Maybe they can think of something better than programs that are to stimulate the economy just long enough (between 2 and 4 years) so they can re-elected.

The employment picture doesn’t look that great either. Yes, the government is hiring but all of this hiring is temporary. Well, maybe the government is hoping that with some extra money earned by the temp Census employees, consumption would increase enough to convince small businesses to hire again. Unfortunately, this just may not work out for the government, as most consumers and small businesses no longer trust the government or the overall system. ‘Conspiracy theorists’ are no longer the ‘few’, they are becoming the majority; and that’s for very good reasons.

We’re glad to see the consumer revolving credit not increasing significantly. In fact, it declined by $8.5bil in April (last reported month). Declining revolving credit certainly doesn’t indicate any significant or steady comeback in retail sales growth. Of course, thanks to the government’s free money programs, the non-revolving credit balance appears to be increasing. But again, for how long can the government pay us to consume? Wow, I just said that the government is paying us to consume! Socialism, welcome back!

Consumers have continued to deleverage their balance sheets, which has lowered their debt payments. Consumption remained flat in April (last month reported) compared with March, but was up Y/Y at a meager 4.6%. This figure is not impressive as April ’09 was also a weak consumption month. The May figure may be slightly better as our consumers may have put their tax refunds to good use. Unfortunately, we believe a better use would be savings, which was again at a low 3.6% rate in April. Overall, the economy would benefit more from higher savings in the long-run. But the government is doing everything it can to prevent the hard working families from saving.

Housing is not looking good either. This week, even with rates remaining at their lowest levels, refinancing declined. Of course, no surprise as the purchase index declined for the fifth consecutive week; again while rates have remained at low levels. This is another example of how well these government programs work, only for the short-term. Let’s hope the home builders didn’t think that this government-induced ‘high’ would last longer. If they do, we can expect another jump in inventory levels during the next few months. The optimists or green sh*ters may point to the latest decline in foreclosure (from the latest RealtyTrac report) rates as an indication of a turnaround. Well, sorry to tell you ‘greenies’ but such decline is accompanied by huge jump in the number of homes that banks have begun to repossess. You see, the banks, for the time being, are ignoring the late-payers in order to take away the properties of the truly non-payers. Banks had been wishing that over time, many of their foreclosures would work out, but unfortunately they haven’t. At this time, banks have no choice but to try and control home inventories. It appears that the best way to do so is to forget about the new foreclosures and try and tackle the old ones. We wish the banks and other lenders a lot of luck.

With all of this said (and we do have a lot more to say as we basically omitted discussion of the latest oil disaster), the market (S&P500) has entered its correction phase, down more than 13% from its high in late April. We continue to believe there is more room for the market to decline. In addition to some things mentioned above, from a technical standpoint, if S&P steadily breaks the 1,050 level, the 1,000 level is doable. If the market dips below 1,000 on heavy volume, then the 950 – 975 level would be realistic.

Hopefully if the market behaves the way that we are anticipating, because then we will likely begin to publish our thoughts on specific soon-to-be under-valued companies. Until then, we remain bullish on gold. As mentioned in our previous note, hopefully our simple strategy will be successful so that we can begin vacationing in the now much more affordable Greek islands for a long, long time.

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