The Market Direction…

Friday’s selloff in the U.S. markets was all about the sustainability of economic recovery in America. The market has been long overdue for a correction, but lest we forget that we are living in the age of the global economy and acknowledge the interdependent economic relationships that shape it, perhaps one should reconsider things from a global perspective. China’s most recent PMI (purchasing managers index) report indicates that the world’s fastest growing G-20 economy has expanded its manufacturing and exports.

Below is an article from Bloomberg’s online news which provides more details on China’s latest economic data release:

"Chinese manufacturing data for October showed the nation’s recovery strengthening and export orders climbing, giving policy makers more room to pare stimulus measures in coming months.

Manufacturing expanded at the fastest pace in 18 months, according to a purchasing managers’ index released by HSBC Holdings Plc today and also a government-backed PMI released yesterday. The HSBC index rose to a seasonally adjusted 55.4 from 55 in September, an e-mailed statement showed..."

As this blog report is being written, the Shanghai Index is trading up +2.5% on Nov-02-2009’s trading session. On Friday, the Xinhua China 25 Index exchange traded fund (FXI) closed down -3.54% @ $41.70, which was just slightly under its 50 day moving average @ $42.01. It is also worth mentioning that as domestic and international markets corrected over the past couple weeks, China’s FXI displayed remarkable relative strength.

This newly released economic news may confirm that China’s stimulus plan is working and its economic recovery is gaining momentum. If so, this provides a fundamental reason for technical support and should support at the 50 day moving average hold its ground, then investors who are not long the FXI may wish to reconsider buying it and/or selling out-of-the-money puts which spiked in value along with the VIX during last Friday’s trading session.

*Disclosures: Hillbent does not provide individualized market advice. The information we publish regards companies in which we believe our readers may be interested and our reports reflect our sincere opinions. Nevertheless, they are not intended to be personalized recommendations to buy, hold, or sell securities. Investments in the securities markets, and especially in options, are speculative and involve substantial risk. Each individual investor should determine their respective appropriate level of risk. It is recommended that you seek personal advice from your professional investment advisor and conduct further independent due diligence research before acting on information published in any of our reports. Most of our information is derived directly from information published by the companies on which we report and/or from other sources we deem to be reliable, without our independent verification.

Therefore, we cannot assure the completeness or accuracy of information contained within these reports and we do not in any way warrant or guarantee the success of any action which you take in reliance on our statements.

Hillbent.com, Inc. or its affiliates may own positions in the equities mentioned in our reports. We do not receive any compensation from any of the companies covered in our reports.

While I clearly acknowdedge the uptrends in equities and that bulls are firmly in control, I have also consistently pointed out that there is a disconnection between the links of fundamentals and technicals. I still believe this is the case, but instead of telling it to you again,  thought that I would let a more experienced guru like Art Cashin be my advocate. In this video below, he provides a very sober take on the markets and I think that anyone with exposure to stocks would be wise to proceed with caution at this juncture.

 As of Sept-17-2009

*Disclosures: Hillbent does not provide individualized market advice. The information we publish regards companies in which we believe our readers may be interested and our reports reflect our sincere opinions. Nevertheless, they are not intended to be personalized recommendations to buy, hold, or sell securities. Investments in the securities markets, and especially in options, are speculative and involve substantial risk. Each individual investor should determine their respective appropriate level of risk. It is recommended that you seek personal advice from your professional investment advisor and conduct further independent due diligence research before acting on information published in any of our reports. Most of our information is derived directly from information published by the companies on which we report and/or from other sources we deem to be reliable, without our independent verification.

Therefore, we cannot assure the completeness or accuracy of information contained within these reports and we do not in any way warrant or guarantee the success of any action which you take in reliance on our statements.

Hillbent.com, Inc. or its affiliates may own positions in the equities mentioned in our reports. We do not receive any compensation from any of the companies covered in our reports.

The Treasury International Capital (aka TIC) report for June 2009 shows that foreign demand for treasuries is not as weak as perceived. It seems that China, which has been doing most of the heavy lifting, took a well deserved rest while Japanese and British investors picked up some of the slack. Overall, the net sponsorship for Treasury coupons by foreigners reached its highest level in 5 years @ net plus $100.5bn (see chart below).

Foreign Purchases of U.S. Treasury Bonds & Notes

Source: Bloomberg

Granted, while the recovery that some economists and media market pundits envision may be government stimulated mirages, further along the time horizon one can recognize signs of stabilization and a plausible escape from Dante’s 9th level of hell in a handbasket. Yet, key industries, e.g. financials, autos, housing, commercial real estate, and consumer retail are fragile or broken and still dependent upon various forms of corporate and social welfare.

Speaking of welfare, the issuance of record amounts of national debt accompanied by declining treasury tax receipts continues to influence my unfavorable secular view on the supply-demand scenario for treasuries. However, with an overextended and overvalued 6 month rally in equities, I suspect that  "safe haveners" instead of "yield whores" are buttressing the containment of rising interest rates. According to Bloomberg, some of the larger pension funds have developed a phobia for risks (see video below) which I interpret as a partial explanation for the phenomenom of rising equity prices on contracting volume.

Pension Funds More Careful About Risks

Of course, all of this is debatable as the weekly chart below shows demand for treasuries at yields approaching the 4% range tends to consistently attract buyers (see weekly chart below). The recent trend for 10 year treasury bond yields is up, but the secular trend remains down (see monthly chart below). Lest we forget, 10 year treasury yields ranging from 4% to 5% are not abnormal under normalized economic conditions and inflation trends in which stocks are expected to offer potentially superior risk adjusted returns. Currently, both the earnings yield (@ 3.66%) and dividend yield (@ 2.65%) for the S&P 500 are below the 4% level.

Weekly Chart of 10 Year Treasury Yields 

 Monthly Chart of 10 Year Treasury Yields

Until we arrive at the new normal - i.e. historically lower nominal GDP growth @ 2.5% - 3%, high mid-single digit unemployment rates, and more modest consumption rates - the economy must endure the abnormal, provided America’s creditors will continue to lend. Monday’s TIC report confirms that this continues to be the case.

Nominal GDP growth in the range of 4% - 5% would be nothing short of miraculous and I do not believe the existing fundamentals support such rates. It looks like we have been sentenced to a Faustian deal with the devil of inflation for the sake of reviving a few banks which supposedly "represent" the U.S. banking system.

Judging from the relative performance of 10 year bonds vs. stocks and recent move above the 20 day moving average (4 week moving average), the bond bogey man is not coming out anytime soon. Banks still require more time to earn their way out of some of the potential writedowns they will inevitably take. When the bond bogey man re-emerges, look for 10 year yields to break out above the resistance of the weekly chart’s downtrend line and the June 2009 high (see weekly chart above).

Weekly Chart of 10 Year Treasury vs. S&P 500

For now, the recently established long-term uptrends for stocks remain intact and it looks like investors might be witnessing the beginnings of a long overdue correction in stocks and tactical re-allocation of capital.

*Disclosures: Hillbent does not provide individualized market advice. The information we publish regards companies in which we believe our readers may be interested and our reports reflect our sincere opinions. Nevertheless, they are not intended to be personalized recommendations to buy, hold, or sell securities. Investments in the securities markets, and especially in options, are speculative and involve substantial risk. Each individual investor should determine their respective appropriate level of risk. It is recommended that you seek personal advice from your professional investment advisor and conduct further independent due diligence research before acting on information published in any of our reports. Most of our information is derived directly from information published by the companies on which we report and/or from other sources we deem to be reliable, without our independent verification.

Therefore, we cannot assure the completeness or accuracy of information contained within these reports and we do not in any way warrant or guarantee the success of any action which you take in reliance on our statements.

Hillbent.com, Inc. or its affiliates may own positions in the equities mentioned in our reports. We do not receive any compensation from any of the companies covered in our reports.

Gather together small business owners, home owners and heads of families and ask them if they’re concerned about their financial position and the answer would be a deafening yes. This is in stark contrast to the relentlessly rising Wall Street.

For six months consecutive the U.S. stock markets have steadily climbed, with a few minor interruptions, to gain almost 50% from the March lows.  The S&P 500 now trades at a hair under 20 times 2009 earnings estimates and yields 2.5%. The risk free yield of the ten year treasury offers close to 4%. Buyers of the S&P 500 at the March lows were locking in a dividend yield that exceeded the ten year treasury, an opportunity which investors have not seen in more than 50 years. (In my March 8,2009 article, http://seekingalpha.com/article/124752-has-irrational-apathy-unduly-depressed-asset-prices, I recommended buying the broad market using SPY)

Stock markets seem to have enough bullish momentum to propel them higher. But profits will be short lived and the current investor confidence will be strained by declining markets sometime this fall. At least three economic facts will stall the upward momentum.

1) An economic recovery based on artificial government stimulus is not sustainable.

2) Corporations are beating depressed earnings expectations by cutting costs (i.e. fewer employees) not growing revenue. Future earnings growth will be difficult to achieve.

3) Sluggish income growth and rising unemployment will continue to hamper the consumer’s habit to spend. The Fed’s artificially low interest rates will rescue the indebted consumer over the short term but may just create another ticking time bomb. Even with programs designed to induce consumer spending, such as the “cash for clunkers” program, retail sales still fell 0.1% in July.

 So what is the serious investor to do? Own solid dividend paying companies which have proven to hold up better in declining markets. The following defensive stocks will grow their earnings in 2010, pay better than a 3% dividend and trade at an earnings multiple far below the S&P 500: AT&T (T), Abbott Labs (ABT), PepsiCo (PEP), Procter and Gamble (PG). In addition, cash pays very little now but U.S. Treasury bonds available through iShares TLT pay more than 4%.

By Brent McCosker (from Quebec, Canada)
Canadian Market Strategist and Contributing Author @ Hillbent.com

Author’s Disclosure: S&P 500 @ 1100; and author owns shares of T, ABT, PEP, PG and TLT.

(Editors Note: Brent McCosker worked as a research scientist for the aerospace and petroleum industries, first with McDonnell Douglas (now Boeing) and Lockheed then Unocal (now Conoco Phillips). He followed his father into finance working as a financial advisor with Morgan Stanley for eight years. In 2002 he and his family moved to Quebec, Canada (his wife is Quebecoise) where they purchased a water analysis laboratory which they owned and operated for three years.  Brent is now a private investor and collaborates with J Clinton Hill on Hillbent.com’s Market Direction blog and investment research products and services. He also holds a Masters degree in Chemistry and in his free time enjoys cross country skiing and long distance cycling.)

*Disclosures: Hillbent does not provide individualized market advice. The information we publish regards companies in which we believe our readers may be interested and our reports reflect our sincere opinions. Nevertheless, they are not intended to be personalized recommendations to buy, hold, or sell securities. Investments in the securities markets, and especially in options, are speculative and involve substantial risk. Each individual investor should determine their respective appropriate level of risk. It is recommended that you seek personal advice from your professional investment advisor and conduct further independent due diligence research before acting on information published in any of our reports. Most of our information is derived directly from information published by the companies on which we report and/or from other sources we deem to be reliable, without our independent verification.

Therefore, we cannot assure the completeness or accuracy of information contained within these reports and we do not in any way warrant or guarantee the success of any action which you take in reliance on our statements.

Regarding guest commentaries and contributing authors, note that Hillbent.com does not officially endorse the commentaries of any contributors and the sole purpose of providing such content of for the convenience of our readers and to further assist their research efforts.

Hillbent.com, Inc. or its affiliates may own positions in the equities mentioned in our reports. We do not receive any compensation from any of the companies covered in our reports.

>>>Market Strategy>>> Meg Browne, Vice President of Forex Research @ Brown Brothers Harriman, sees growth and interest rate differentials being the major drivers for currencies in Q4-2009. She is bullish on the dollar and believes that as it becomes apparent that real economic data points to strength in the U.S. economy, the dollar will begin to make its move.

The video interview is @ 2:30 minutes and is hosted by Bloomberg television.

Source: Sling.com

*Disclosures: Hillbent does not provide individualized market advice. The information we publish regards companies in which we believe our readers may be interested and our reports reflect our sincere opinions. Nevertheless, they are not intended to be personalized recommendations to buy, hold, or sell securities. Investments in the securities markets, and especially in options, are speculative and involve substantial risk. Each individual investor should determine their respective appropriate level of risk. It is recommended that you seek personal advice from your professional investment advisor and conduct further independent due diligence research before acting on information published in any of our reports. Most of our information is derived directly from information published by the companies on which we report and/or from other sources we deem to be reliable, without our independent verification.

Therefore, we cannot assure the completeness or accuracy of information contained within these reports and we do not in any way warrant or guarantee the success of any action which you take in reliance on our statements.

Regarding guest commentaries and contributing authors, note that Hillbent.com does not officially endorse the commentaries of any contributors and the sole purpose of providing such content of for the convenience of our readers and to further assist their research efforts.

Hillbent.com, Inc. or its affiliates may own positions in the equities mentioned in our reports. We do not receive any compensation from any of the companies covered in our reports.