A Brief Weekly Review and Outlook

Last week was a continuation of an exuberant market during earnings season and a flailing economy complete with bad housing data and seven additional FDIC bank closings. The bulls argue corporate balance sheets while bears focus on the economic data. So, which is safer; driving looking into the rear view mirror or the windshield?

There is near unanimous agreement in the market that deflation has defeated inflation. Unanimous consensus always makes me nervous. Looking around the US, deflation is prominent, with all things real estate. However, US real estate is losing its impact, month by month, on the global economy.

What cannot be timed is when global growth, and the inflation that comes with it, overrides the drag of American real estate.

The amazing Treasury bond market is like sleeping with a very large snake; hopefully, you wake up first. The bond market is pricing in a near depression, perhaps, while the stock market is celebrating business as usual. Or, the rest of the world is madly purchasing US debt, thereby, driving down yields, as there is no safe alternative to treasuries, at the moment. The wild card is government intervention – or the lack of it – from an economic perspective.

On the other hand, the municipal bond market continues to offer a much better yield, although, 41 out of 50 states are insolvent, and all five Gulf States are exposed to loss of revenue and clean up expenses from the BP oil spill.

Gold was up $1 buck last week. Gold is still outperforming stocks for the year.

The week ahead offers more corporate earnings reports and several important economic reports.

The Second Quarter T.K.O.

Friday morning the big number, the BLS Employment Situation, landed with a thud. The unemployment rate drifted down to 9.5%, private sector jobs increased by 83,000, the non-farm payroll employment loss was 125,000 and the birth/death rate adjustment figure was 144,000. Government jobs shed 90,000 and 652,000 job seekers left the market. Two-hundred twenty-five thousand temporary census workers were let go. The average workweek fell 0.1% to 34.1 hours and the average earnings also fell 0.1%.

Before we pick up our swords and shields in the third quarter to do battle for gains and profits with a rising Euro, a weakening dollar, massive state and local spending cuts, possibly minimum wage wages for California state employees, a chronically ill housing market, fugitive employment and falling consumer confidence, let’s review the barrel we found ourselves spinning in throughout the second quarter.

The second quarter was one of the most brutal trading quarters I have seen in 27 years, in investing. Here are a few second quarter headline stats from the WSJ MarketBeat Blog: for the DJIA - down 1082.61 points, or 9.97% to 9774.02, the worst quarterly performance since 1st Quarter 2009; S&P 500 Index - down 138.72 points, or 11.86% to 1030.71, the worst quarterly performance since 4th Quarter 2008; and NASDAQ - down 288.72 points, or 12.04% to 2109.24, the worst quarterly performance since 4th Quarter 2008.

These loses are comparable to those we experienced when we were in the thick of the meltdown. Unlike the express elevator to hell we were trapped in the last half of 2008 and the first quarter of 2009, this was a Six Flags rollercoaster ride that took our cash, our lunch, and our sanity. Investors should not hold their heads down in shame. Professionals did not trade this quarter well either. If this quarter had been a boxing match they would have stopped it. This was not an investors’ market and the last week in the quarter told the story.

Referees stop fights when fighters can no longer protect themselves in the ring. Boxers cannot block punches, jab, counterpunch, move on their feet, or throw a combination. Their eyes have a glassy stare. They are unaware of their circumstance.

The last week of the month and quarter is for profit taking and window dressing. Markets are purposely traded. This market, this week, responded not at all based on its whereabouts. Compare the first quarter to the second quarter.

In the first quarter, the market rallied from the start of the year until January 19th. It sold off until the first week in February. Then, it counterpunched and fought it way back to new yearly highs to end the quarter. The beginning of April saw the same fight in the market. A rotation in sectors kept the market moving forward. Traditional punches landed but did little damage to the rally.

Before the second quarter bell ranged, on March 29th, the 7-year Greek auction bombed. On April 19th, the yield spread between Greek and German bonds hit 469 basis points. Then, on April 20th, the BP oil spill occurred. These events rocked the market. On May 6th, the flash crash occurred and markets never really recovered. The market staggered for the rest of May. Investors should have exited the market here. Money managers were tightly clenched throughout June by FinReg negotiations in Washington. Markets and investors set themselves up to win the second quarter on points with improving economic data being released this week. The improvement in the economy did not materialize.

A market hurt and running out of gas whose only hope of surviving was avoiding any more blows and to catch a break. Luck turned out not to be a lady, but rather, a loud, nasty, violent drunk. The oil spill worsened with failed attempts to cap the well, accompanied by pictures of gulf coast estuaries being damaged, innocent wildlife being murdered, and the first hurricane to enter the Gulf of Mexico in June in 15 years. Also, actions of austerity around the world by governments – our allies - were counterproductive to the US economy recovery narrative. The Euro’s fall reversed. The unemployment picture did not improve.

The rally from the spring of 2009 was predicated on the assumption that economic recovery would support higher valuations. Without significant improvement going forward, the markets were overvalued. The only market that withstood the shots of international governmental policies, macroeconomic trends, and supply/demand curves was the mellow yellow – Gold. Au – 196.9665, which refused to be knocked out.

One of the most stunning championship fights in history was the 1965 rematch between, then, current Heavyweight Champion Mohammed Ali and former Heavyweight Champion Sonny Liston. For years, boxing fans argued about the “phantom punch” which knocked out Liston in the first round. Today, we’re still debating what caused the May 6th flash crash. The bottom line is that the explanation or truth for either event is moot; history has recorded Sonny Liston’s loss in a small auditorium in Lewiston, Maine and the 1,000 point drop within minutes did grave technical and psychological damage to the markets.

This third quarter market is no longer the same cyclical bull rally that began in the spring of 2009. The bell has rung, the secular bear is advancing across the ring and he is fighting mad.

The Lazarus Rally in 2010

This week marks the one-year anniversary of the market bottom for stocks following the 2008 collapse of the supply-side themed western financial system. A deceased stock market, the second week in March 2009; the major averages resurrected themselves, like Lazarus, on a holy-water flood of liquidity, more than any other cyclical bull market bounce in history.

The Dow Jones Industrial Average advanced March 9, 2009 to March 9, 2010, from a gut-wrenching 6,547.05 to 10,564.38. Likewise, the Standard & Poor’s 500 Index moved from 676.53 to 1140.45. The NASDAQ 100 climbed from 1043.87 to 1,901.38, over the same 365 days. These returns equal a decade’s worth of historical gains.

To those investors, who grew feathers, and ran to the sidelines, take heart; in investing, there are lies, damn lies, statistics, and market returns. At the beginning of 2009, the DJIA started at 8,801.72, the S&P 500 Index at 902.99, and NASDAQ at 1,212.24. Only the luckiest of people and your typical liar coolly strolled into the market that second week in March last year, aggressively bought stocks, and are still holding those positions.

Closer to the truth, an experienced bull investor last March probably started taking profits off the table in early summer. Or, they screwed up their courage in April or May and bailed in September, or year end. Anyone capturing these once in a lifetime returns should be running full page ads of their trade confirms announcing the opening of their new hedge fund. And why not, they could afford the advertising rates. Unfortunately, 2009’s trend will be swapped for market fluctuation in 2010.

So, where do we go from here? The answer for the stock market is quite different from the answer about the economy. Let’s first look at the stock market.

Stocks will not repeat the performance of the last 12 months. The last 12 months was fueled on liquidity and promised future growth. The future is here but the growth is not. Wall Street Cardinals assigned to Washington DC, Ben Bernanke and Timothy Geithner, will be less helpful to stocks over the next 12 months.

U.S. Quantitative Easing has an expiration date on its existence. Some central banks have already begun raising rates because their economies are moving forward, unlike ours. The retail customer has yet to return to the market, either through their company’s retirement account (which is hard to do when you no longer work for a company), or taxable investment accounts; when your 1%-2% bearing CDs and T-Bills, and falling home values no longer contributes to your positive cash flow.

Also, investors are going through Post Traumatic Stress Syndrome (PTSD). The dot.com bubble, the Enron era of scandals, the real estate depression, and 2008, has left baby boomers dazed and confused. They are reluctant to hop into the barrel one more time before retirement.

Despite paraphilic dispatches by CNBC anchors, reporters, and guests of an aroused recovery, to the contrary, the U.S. economy is impotent based on low tax receipts, high unemployment, and contracting housing prices and available credit. This is what occurs during a period of deleveraging.

Disposable income from the safest fixed income investments has all but disappeared. That retired couple that spent their 5%-6% interest from their fixed income portfolio to shop, to travel, and to dine has temporality lost over 70% of their purchasing power. Fewer transactions equals fewer sales taxes, in turn, equals less state and federal revenue. Becoming smaller becomes a vicious cycle.

In October and November of 2008, when extraordinary unilateral decisions were made to save the economy, two additional smaller adjustments would have made a huge difference; temporarily change the tax laws for five years, permitting individuals to write off all interest payments for credit cards, automobiles, etc. on their taxes, and to suspend for five years the provision in the Monetary Control Act of 1980 eliminating usury laws. Individuals would have extra cash inside their annual tax return and smaller monthly finance payments. How could banks complain since the Federal Funds target Rate was set December 16, 2008, at 0.00% -0.25%? Their return on borrowed capital is infinity.

Cities and states across the nation will become the biggest drag on the economy in 2010. Dramatic budget cuts to reduce a currently projected $180 billion shortfall are being debated for the 2010-2011 budgets, at this moment, thereby, violently truncating personnel and services.

Banks are still failing. The FEDS feel that they dare not raise interest rates without a very good reason. But, with banks not lending, or reducing credit lines to businesses, and credit cards rates were hiked before new banking credit cards laws were changed, I’m unsure who might be hurt by an increase. Top-down stimulus programs are inefficient and growing more unpopular. Both commercial and residential real estate are not improving And, the November elections will drive sagacity from public conversation.

Internationally, what we can see are sovereign debt problems and a suspect economy in Europe. Tensions growing in the Far East over; military bases, and now Toyota, with Japan; trade disputes and sanctions and political disagreements over Taiwan, Tibet, and Iran, with China. Plus, we have an amorphous exit strategy in Iraq and Afghanistan.

Adding up tapped out consumers, the continuation of deleveraging, near insolvent municipalities, and a gradual reduction of liquidity, what you have is a somber national economy with too few pockets of strength.

Traders relying on volatility and stock pickers that can hunt for appreciation will have several opportunities to feast, however, investors hoping for an expanding economy will soon wish for 2010 to be over with nothing but apples (AAPL) and chips (PEP) and cokes (KO) to snack on in the interim.