Friday, June 20, 2014 - Wall Street’s Midsummer Night’s Dream

Financial Review with Sinclair Noe

DOW + 25 = 16,947
SPX + 3 = 1962
NAS + 8 = 4368
10 YR YLD un = 2.62%
OIL + .83 = 107.26
GOLD – 5.60 = 1315.70
SILV + .12 = 20.98

Both the Dow and the S&P closed at new records, with the Dow hitting an intraday high of 16,978. For the week, the Dow was up about 1 percent, the S&P 500 was up 1.4 percent and the Nasdaq was up 1.3 percent.

Today is the last day of spring. The solstice will occur tomorrow morning at 6:51 AM Eastern time, so tomorrow is technically the first day of summer, and the longest day of the year, or at least the day with the most daylight. For the western states, we’ll have solstice at 3:51AM, so there really will be some Midsummer Night’s Dreams. The markets have been drifting in and out of fantasy and reality this week.

On Wednesday, Federal Reserve Chairwoman Janet Yellen said the Fed would keep doing what the Fed does, and all the markets heard “buy, buy, buy.” Wall Street traders opened their eyes from a Midsummer Night’s Dream and fell in love with the first trade they saw.

Yellen said inflation was just “noisy” and interest rates could stay "well below longer-run normal values at the end of 2016." Yellen nonetheless cited reasons for optimism about the economy, including resilient household spending and an improving jobs market, even as the Fed lowered some of its economic forecasts. This is a recurring theme. The Fed’s forecasts for economic growth in 2014 have resembled a downward slope. They cut their forecast on Wednesday from the range of 2.8% - 3.0% down to 2.1% -2.3%. Back at the start of 2012, the Fed thought this year, we would see 4% growth. At the start of this year, they expected 3.5% growth.

Meanwhile, the IMF is warning government officials around the world to prepare for the time when the Fed and other advanced economy central banks do raise interest rates. Not that rates will rise soon or fast, but eventually they will rise, and the IMF hopes to prolong that time, even if it risks fueling asset price bubbles. The long lead time before Fed rate increases should give governments around the world more time to get their economic houses in order. However, it also may encourage undisciplined governments to put off reforms. The IMF believes disruptive market volatility is one of the biggest risks in the years ahead.

And then there’s the question of how the Fed will actually exit QE. At the beginning of 2007 the Fed held assets totaling about $880 billion. Today, the balance sheet stands at about $4.3 trillion, including $2.4 trillion in treasuries and $1.7 trillion in mortgage backed securities. This was the Fed’s attempt to drive down actual rates on actual loans to people and businesses, with the idea that lower rates would stimulate demand. The Fed can set a target for the Fed funds rate, but that’s just a target.

Anyway, all those bond purchases worked, sort of; long term rates dropped relative to short term rates and risky obligations. The best guess is that long term interest rates dropped about 25 basis points for every $600 billion in bond purchases. And buying mortgage backed securities helped push down mortgage rates, which was helpful in putting a floor under housing prices, and likely spurred some construction, although the housing market seems to be stalled right now.

The Mortgage Bankers Association yesterday lowered its forecast for combined new and existing home sales in 2014 to 5.28 million; a decline of 4.1% that would be the first annual drop in four years. The group also cut its prediction on mortgage lending volume for purchases to $595 billion, an 8.7% decrease and the first retreat in three years. The big housing rally wiped itself out because prices increased too quickly for buyers to keep up. The pool of eligible new buyers is collapsing because of stagnant incomes and lack of credit. This revealed one of the biggest problems for the Fed’s stimulus plan; they could indeed lower rates, but they couldn’t direct distribution.

Could the Fed get back to pre-crisis balance sheets? Probably not, but they can just hold the bonds to maturity. There really doesn’t seem to be any viable option, and if the Fed continues to hold those securities, it’s a safe bet they won’t be trying to push rates too high too fast. At the same time, however, the Fed reinvests billions of dollars from maturing securities, about $16 billion each month this year, to maintain the size of its holdings.

The Fed once planned to stop reinvesting, allowing its holdings to dwindle, soon after it ended the expansion of the portfolio. In 2011, the Fed said this would be its first signal that it was winding down the stimulus campaign. But there is growing support among Fed officials to preserve the portfolio’s size instead.

Fed officials generally argue that the effect of bond buying on the economy is determined by the Fed’s total holdings, not its monthly purchases. In this view, reinvestment would preserve the effect of the stimulus campaign. Not everyone agrees with this assessment; some people believe the flow of funds is more important than the size of the balance sheet. The Fed in recent years has almost completely replaced its inventory of short-term government debt with longer-term securities that do not begin to mature until 2016.

And the composition of the balance sheet means that the Fed will have a whole bunch of paper maturing in early 2016. What they do then will be important. Reinvesting will have a fairly significant jolt for the economy. Many in the Fed have come to accept the bond holdings as a fact of life. In 2011, when the Fed first described its exit plans officials believed that reducing the Fed’s bond holdings was a necessary step to maintain control of inflation. Maybe that’s why Yellen can dismiss inflation as being nothing more than noise. So, even as the Fed reduces purchases, the overall balance sheet remains large, and reinvestments will be significant, and their feeling is that raising the target on interest rates will only provide flexibility with monetary policy.

It all sounds good on paper, but I still think the process will be a bit painful, with unintended consequences.

Let’s get you up to date on the situation in Iraq. Ayatollah Ali al-Sistani, an Iraq cleric considered one of Shia Islam's leading voices, has called for creation of new government that avoids past mistakes; so it looks like prime Minister Maliki is in trouble. Sistani called for national unity. The Pentagon says it has seen evidence of "small numbers" of Iranian troops in Iraq but no sign of a major deployment by Tehran.

Obama said yesterday he was prepared to send up to 300 military advisers to help the Iraqi security forces. The special forces troops will work in teams of around 12 and be based mainly at the headquarters of the Iraqi military, with some deployed to individual brigades. The Pentagon said today that the first couple of teams will be made up US troops already in Iraq at the embassy but that as of now no additional units had been sent.

UN Secretary General Ban Ki-moon has effectively endorsed Barack Obama's decision to hold off from ordering air strikes in Iraq, saying that any such action would likely be futile or could even backfire: "Military strikes against ISIS might have little lasting effect or even be counter-productive if there is no movement towards inclusive government in Iraq."

The oil refinery in Baiji, in the north of Iraq, has reportedly fallen to the ISIS rebels. And fighting continues, with most of the battles being won by the rebels. If you are still unclear about the events on the ground in Iraq, you are not alone. According to a Newsweek report, US intelligence has lost virtually all its local assets to be left effectively blind in the country:

“The “surprising” collapse of the Iraqi army and the defection of key Sunni tribal leaders to al-Qaeda-inspired insurgents has largely stripped the CIA of spies in … country. As a result, according to a US intelligence official, the CIA is mostly relying on “technical means”—electronic intercepts of all kinds—and the support of friendly regional secret services, like Jordan’s, to monitor the rapidly deteriorating situation.

Oil prices have inched up but not as much as some feared they would, considering that Iraq is the second largest producer in OPEC. If its supply was completely disrupted, it would take all of the world’s surplus production capacity to replace it.

Gasoline prices typically fall in the weeks following Memorial Day, after supplies increase enough to fill up the cars of the nation's vacationers as summer approaches. This year, drivers are paying more. The national average price of $3.67 a gallon is the highest price for this time of year since 2008, the year gasoline hit its all-time high.

Monday, June 09, 2014 - Record Highs and a Few Crumbs

Financial Review with Sinclair Noe

DOW + 18 = 16,943
SPX + 1 = 1951
NAS + 14 = 4336
10 YR YLD + .02 = 2.61%
OIL + 1.73 = 104.39
GOLD - .30 = 1253.00
SILV + .05 = 19.16

The major indices are now up for 4 consecutive sessions. The Dow Industrials hit a record high close for the 10^th time this year. The S&P is now up 14 of the last 17 trading sessions. The last time the Dow experienced a 10% correction was back in October 2011; since then, the Dow has gained almost 60% over 32 months without a 10% correction. Typically, you can expect a correction about every 12 months on average. The longest period without at least a 10% pullback was an 82 month run from 1990-1997. The S&P 500 hit a record high close for the 19th time this year. The S&P bull market is now at 62 months and counting, the best run since 1994 to 2000.

The CBOE Volatility Index moved a little higher today to 11.34. On Friday, the VIX hit a low of 10.73, the lowest level since January 2007. The VIX can go low and stay low for an extended period of time. In 2007, after hitting a low, the VIX steadily rose for the remainder of the year but stock prices didn’t peak until the end of 2007. The VIX measures options trades, but does it really mean investors are dangerously complacent? The Murdoch Street Journal reports: “Last week, 39% of respondents to a long-running weekly survey from the American Association of Individual Investors said they were bullish about stocks. That is well above readings of just over 27% in both February and April, when violence in Ukraine weighed on sentiment. But it is far from giddy. In fact, it is in line with the average since the poll's inception in 1987.”

Today had all the signs of a bull market, in addition to record highs, we had a good old fashioned Merger Monday. Tyson foods agreed to buy Hillshire for $8.5 billion, or $63 a share cash. That follows a bidding war between Tyson and Pilgrim’s Pride that pushed Hillshire from $37 a share on May 23 to the current bid.

Drugmaker Merck paid $3.9 billion, or $24.50 a share in cash for Idenix Pharmaceuticals, a 240% premium to Friday’s close of $7.23. Idenix has three drugs to treat Hepatitis C in clinical trials, but none on the market. Chipmaker Analog Devices agreed to buy Hittite Microwave Corp for $2.5 billion, or $78 a share, a mere 29% premium to Friday’s close.

Depending on the source, deal volume is up about 65% to 70% this year. Worldwide, companies are sitting on about $7.5 trillion of cash. With organic top line growth hard to come by in sluggish economies, many are turning to acquisitions.

You can buy a share of Apple for about $93; that following a 7 for 1 split; the first split for Apple in 9 years. A split is generally a non-event. If you owned 100 shares of Apple on Friday, you now own 700 shares, but the price was divided by 7. The financial structure and value of the company doesn’t change.

The yield on a 10-year US Treasury note was up a couple of basis points today to 2.61%. Meanwhile, the yield on the 10-year Spanish government bonds dropped 5 basis points to yield 2.59%. Normally, you would expect a government bond yield to correspond to demand and overall safety of the bond and the country backing the bond. Things are a little upside down. The good news is that investors aren’t expecting the Eurozone to disintegrate; the bad news is that investors aren’t expecting any growth in the Eurozone.

James Bullard, president of the St. Louis Federal Reserve Bank, speaking at a conference in Florida today, said the US macroeconomy is much closer to a normal state than it has been in 5 years and only weak labor markets and low inflation is keeping the Fed’s accommodative monetary policy in place. Last month, Bullard said that while the housing and labor markets remain weak, he expects recovery through the rest of the year, and said inflation would likely move towards the Fed's desired 2% rate.

Bullard told reporters after his speech: “If you get 3% growth for the rest of this year, if you get unemployment coming down below 6%, if you continue to have jobs growth at 200,000, if you continue to see inflation moving back up toward target, I think if we get to the fall of the year and all of those things are transpiring as I’m suggesting they will, that will change the conversation about monetary policy, and there will be more sentiment toward an earlier rate hike.”

The housing market may not be as strong as some Fed policymakers believe. On Friday, the jobs report showed the economy had regained all the jobs lost in the recession, but that isn’t the case for the home building sector. The number of construction jobs has been climbing, rising about 7% in May from a year earlier, to 2.6 million, including electricians and other specialty trade contractors; but that's way down from the high of 3.45 million in April 2006. While jobs overall are back to their pre-recession peak, residential construction jobs are 34% below their peak.

Even five years after the housing meltdown, a sizeable chunk of homeowners remain underwater. About 6.3 million homes, or 12.7% of all properties with a mortgage, were underwater as of the first quarter.  About 1 in 10 homeowners are almost underwater, with less than 10% equity in their homes, meaning it would probably cost them to sell, when including selling related expenses.

A survey released last week by the MacArthur Foundation found that 43% of those polled said it is no longer the case that owning a home is an excellent long-term investment and one of the best ways for people to build wealth. More than half said that buying a home has become less appealing than it once was. And 70% believe the nation is still in the middle of a crisis and that the worst is yet to come.

One major demographic group that isn’t buying homes is the Millennials; they are just trying to pay off student loans. President Obama announced Monday that he will expand a federal program designed to reduce student loan payments. The program, called “Pay As You Earn”, will give as many as five million more Americans with federal student loan debt the ability to cap their monthly student loan payments at 10% of their income and to have their remaining debt forgiven after either 10 years (for government and some non-profit workers) or 20 years (for other workers).

The current program is only available to Americans who began borrowing after October 2007 and kept borrowing after October 2011; the new order will allow students who borrowed money before October 2007 and those who have not borrowed since October 2011 to participate. The new program will begin in December 2015.

Of course, like so much consumer debt, if you pay the smallest monthly minimum, you just string out the loan and end up paying more over time; so, the new plan might not work for everybody. The best idea is to work some numbers, comparing monthly payments and lifetime costs; there are calculators for this at the Department of Education website.

The housing market is just one factor in an economy that doesn’t seem quite as strong as Fed President Bullard suggests. This was supposed to be a breakout year for economic growth but it started with negative GDP in the first quarter. And even though we have regained the jobs lost in the recession we still have nearly 10 million unemployed, and that’s more than 2 million more than in January 2008; and the quality of the jobs, and the pay has gone downhill for most workers. Income growth is at its lowest point since 2007. When people are shopping, they’re using borrowed money.

Corporations and Wall Street raked in profits unseen in their history. At the end of 2013, corporate profits hit an all-time high of $1.9 trillion. Those profits were largely achieved not by growing, but by cutting jobs and investments; and relying instead on mergers, buybacks, stock splits, QE, and other financial legerdemain.

The economy hasn’t really turned positive. It could change. Maybe the Fed will quit QE and try something that actually helps the economy. Until then, enjoy your milk and cookies, or whatever crumbs might come your way.

Wednesday, May 21, 2014 - Congratulations Graduates, Yada, Yada, Yada

Financial Review with Sinclair Noe

DOW + 158 = 16,533
SPX + 15 = 1888
NAS + 34 = 4131
10 YR + .02 = 2.53%
OIL – .33 = 103.74
GOLD – 2.40 = 1292.90
SIL  un = 19.49

Earnings season is winding down; about 96% of S&P 500 companies have reported results, with profit growth this quarter of 5.5% and revenue up 2.8%. While more companies have topped earnings expectations than usual, fewer have beat on the revenue side. This has been an ongoing theme for corporate profits; bottom line growth without corresponding sales. If this formula sounds unsustainable, it is, unless there is some other factor pumping up the markets.

Follow-up from yesterday: China has signed a 30-year deal to buy Russian natural gas worth about $400 billion. The gas deal gives Moscow an economic boost at a time when Washington and the European Union have imposed visa bans and asset freezes on dozens of Russian officials and several companies over Ukraine. It allows Russia to diversify its markets for gas, which now goes mostly to Europe; essentially opening the door to Asia’s gas market and potentially closing the door on the petro-dollar.

The Federal Reserve today released the minutes of the most recent FOMC meeting. Fed policymakers considered several approaches to tightening monetary policy, but decided to remain flexible; which is another way of saying QE is a big experiment and they are just hoping nothing explodes in their face. By making no decisions, the Fed is making it difficult for Wall Street to be spooked by tightening talk, at least for now.

In the minutes, the Fed made no decisions on which tools to use. One great advantage of extending the debate about how to tighten is that it keeps the question of when stuck in background. If the Fed laid out a detailed exit strategy the markets would start to trade the strategy and essentially kill it in its tracks.

The minutes show the Fed still thinks the first quarter slowdown was weather related, and things will pick up, any day now. Fed officials still see slack in the labor force, but there wasn’t consensus on how much slack or what to do about it. Inflation is picking up just a little, but is regarded as stable and not a problem.

After the minutes were published, we heard from several Fed officials, starting with Janet Yellen delivering a commencement address to NYU grads. Yellen delivered what you might expect, and nothing to do with monetary policy: graduates, she said, should “tend the fires of curiosity,” listen to others, show grit in the face of failure, and the courage of her hero Ben Bernanke (yada, yada, yada).

Federal Reserve Bank of San Francisco President John Williams said he’s inclined to delay any action that would allow the central bank’s balance sheet to get smaller until after the Fed has lifted interest rates for the first time. Williams  believes the Fed needs to take into account the troubles it had last year when it first floated plans to wind down its bond-buying policy, and make sure markets understand what the central bank does with its bond holdings is entirely different than what it does with short-term rates.

Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said the Fed is still failing to deliver on its employment and inflation goals. Kocherlakota says the current unemployment rate of 6.3% overstates the nature of the improvement. He said the labor market is not healthy but he didn’t call for additional levels of stimulus, but he did say it was possible for the Fed to switch to a system where instead of targeting a specific level of inflation, it could shift to a regime where it allowed inflation to rise above target to make up for past shortfalls.

One area of agreement in the FOMC minutes is that officials are concerned about weakness in the housing market; citing factors like higher home prices, construction bottlenecks from a shortage of labor and harsh winter weather, as well as tight credit.

Former White House advisor Larry Summers thinks student debt is slowing the housing market, which in turn is slowing the broader economy. Since 2003, student loan balances have nearly quadrupled to $1.2 trillion, during a period when mortgage debt rose “only” 65% to $8.2 trillion and credit card debt actually declined by 4.2% to $660 billion. The burden of servicing that ever growing student loan debt is eating into other forms of borrowing and spending, such as the purchase of a home. And so the proportion of first-time buyers has been shrinking for years.

Over 70% of the students who are sitting through a commencement speech this spring have student loans. They will start their career, if any, with about $33,000 in debt. Even when adjusted for inflation, it’s about twice as much as 20 years ago. Back then, only 43% of students graduated with student loans. And as education costs have jumped, the idea of working your way through school just doesn’t work anymore.

One of the reasons why education costs have jumped is because of austerity. States cut back on funding for state universities; the schools raised tuition and they discovered they could charge whatever they want, or get away with, because the students just borrow the money. Once upon a time state governments held the reins of university budgets and they would tighten their grip occasionally; no more; and through the student loan programs, designed with whatever intentions, the government is simply aiding and abetting colleges in extracting ever more money from the future lives of their students.

And so for the Class of 2014, you now face the prospect of rising interest rates, a mountain of student loan debt, almost no chance of buying a home in the foreseeable future, and the prospects for a good job in your chosen field are not looking good. Congratulations, don’t despair, just have the grit and courage of Ben Bernanke (yada, yada, yada) and you’ll work your way out of your parents’ basement in 10 or 15 years.

Earlier this week, the Oregon Legislature approved a plan that could pave the way for college students to finance their education by selling equity stakes in their future income. It’s an interesting idea. With both unsubsidized and subsidized Federal loan rates now at 6.8%, and Grad PLUS rates even higher, the student loan burden that comes with an undergraduate degree, let alone further education can be daunting. Unfortunately, Federal loans are often the only option that a student has to pay for school nowadays.

Equity financing would allow these students to avoid debt in exchange for a portion of their future income for a set number of years. Proponents of the Oregon plan claim that 3% per year for 20 years would be enough to keep the program afloat. One concern is that students who expect to be high earners will not participate if it could mean they end up paying more in tuition when all is said and done. Equity financing would be costly for a medical student. A cap on repayment could help solve such a problem. The cap would still have to be higher than the average tuition rate charged by the school. Meanwhile, a equity financing might be a sweet deal for a student taking classes that don’t lead to a big paycheck; it might even encourage them to pursue higher education without regard to finance.

The best that can be said for the plan is that it is a tax on future earnings, the worst is that it is a newfangled name for indentured servitude.

So, back to the housing market for a moment; you have a massive number of young adults living at home with very little financial means for purchasing a home. The recent argument was that as economies grew, this wealth would eventually lift the standard of living for all. There is new economic research showing that this isn’t always the case especially when a rentier class emerges. In fact, this wealth gap is being fully visualized through real estate. Some analysts have been scratching their heads wondering how housing prices could go up while homeownership is actually falling.

How do you have soaring home prices with household incomes dropping? The fact that investors are dominating in the housing market shows how large and powerful these big pools of money have become. The financial sector rarely had an interest in being actual property owners until the housing market imploded. But in the first quarter of this year, cash sales from investors reached an all-time high; that isn’t Mom and Pop buying a crib with cash and it certainly isn’t the first time buyer a few years removed from college.

Since 2005, we have increased the number of rental households by roughly 7 million (a 21 percent increase). Interestingly enough, we have a foreclosure graveyard of 7 million over this same period. Owner occupied housing has actually fallen over this period. We are looking at close to one decade of data and we have fewer individual homeowners today than we did in 2004.

In previous recoveries, you would also see home building picking steam up but that hasn’t happened. In better days, we would see more than 2 million housing starts per year. In this recovery, we’ve been doing our best to close in on 1 million.

And when the Fed last year floated the idea of taper, the markets responded with a taper tantrum, and rates increased, modestly, but an increase; and that was enough to slam the brakes on regular home buyers last year. Mortgage apps are now near an all-time generational low. Regular buyers are becoming a minority. Many of the “pent up demand” argument assumes first, that younger buyers have the means to buy. Second, it also assumes homes are affordable based on their income (which they are not). And so we have cash investors, spurred on by strong stock returns, but what happens if or when the inevitable stock market correction comes along?

Wednesday, April 30, 2014 - Record Highs in First Gear

Financial Review with Sinclair Noe

DOW + 45 = 16580.84 (record close)
SPX + 5 = 1883
NAS + 11 = 4114
10 YR YLD - .04 = 2.65%
OIL – 1.59 = 99.69
GOLD – 4.60 = 1292.30
SILV - .29 = 19.25

Back on December 31^st, we finished the old year with a record high close on the Dow Industrial Average at 16,576; since then the index has bobbed up  and down, briefly hitting an intraday high of  16,631 on April 4^th, but on that day we finished in negative territory. Today, a record high close. The S&P 500 is closing in on the record high close of 1890, but not today.

Now, when you hear the Dow is breaking records, you might think the economy is roaring, cruising along the highway in fifth gear. You would be wrong; the economy is stuck in first gear and the clutch is slipping. The Commerce Department reports the economy expanded at a mere 0.1% annual pace in the first three months of the year, one of the weakest rates of growth in the nearly 5-year-old recovery.

A slowdown had been expected due to the harsh winter weather that froze business activity across a large swath of the country, but this report was worse than expected. The gross domestic product had been expanding at a 3.4% pace in the second half of last year. No worries, the weather has warmed and everything is returning to normal. Yeah, not exactly.

There has been a rebound in the monthly data for March but there have been some disappointments as well. On the positive side, households have pared down some of their debt, credit is a little more available, and consumer spending should bounce back. Even the 2% growth in consumption spending is not all that encouraging; 1.1% of that consumption growth, more than half, was attributed to higher household expenditures on health care.

Home construction is likely to pick up speed as the weather improves, but the housing market seems to be slowing down, with reports this week on new home sales turning soft and existing home sales turning negative in many areas. Residential investment has been negative for 2 quarters. The housing market probably won’t deliver much horsepower as the engine of economic growth but it should be a little better than the winter months, when many parts of the nation were frozen.

An area of concern is business investment, as company spending on equipment fell in the first quarter, and the 3 quarter average is barely positive. The change in inventories subtracted 0.57 percentage points from growth in Q1, exports subtracted 0.83 percentage points. The outlook for trade is soft; the US is not immune to weakness overseas; China’s economy has slowed; there are problems in the Eurozone; and emerging markets are still struggling. Meanwhile, incomes have flat lined and unemployment remains unpleasantly high.

On Friday we’ll get the monthly jobs report. Today, we got a preview from ADP, the human resources firm, and their data shows the economy added 210,000 jobs in April. The ADP report showed hiring picking up in nearly all industries and company sizes; it just isn’t picking up at a real fast pace.

The Federal Reserve FOMC wrapping up their policy meeting and they issued a statement that they will keep policy on the same track; interest rate targets are unchanged and the taper continues with another $10 billion in large scale asset purchases cut this month, to a mere $45 billion a month. The central bankers said that economic activity “slowed sharply” earlier in the year but noted it has “picked up recently.” And “The committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions.”

The disappointing reading on economic growth earlier in the day underscored how bumpy the road back to normal can be. The FOMC statement repeated language from its last meeting in March stating that it will consider the country’s realized and expected progress toward full employment and 2% inflation in determining when to increase rates. The Fed also reiterated that it will take into account “a wide range of information,” including the health of the labor market, inflation pressures and financial developments. In some ways, you could look at the continuation of the taper as a vote of confidence from the Fed. Fed policymakers have said that the phaseout of bond purchases is not on autopilot; the Fed can speed it up or slow it down, depending on how the economy progresses, but apparently the weak GDP number today was not convincing enough to alter expectations; or maybe GDP falls outside the Fed mandate of price stability and maximum employment, and maybe it isn’t something they should specifically pinpoint. Of course, if the economy turns south, they will have to deal with it.

Many Americans are still wondering when the recovery is going to start, but by economic measures, the economy stopped shrinking and started growing in June 2009, the official start of the recovery. That was 58 months ago. Since 1945, the average length of a business-cycle expansion has been 58 months. So if the current recovery continues, it will end up being longer than average, not to mention much weaker. And today’s GDP number was right on the edge of recessionary. The cold weather excuse only goes so far. Already in the second quarter we’ve had deadly and damaging tornadoes, and as the weather continues to warm, we’ll deal with the effects of drought. You have to wonder if the economy was plagued by more than just weather last quarter.

That doesn’t mean we are now entering a recession; we may be close but we aren’t there yet, and we may still rebound, but this affords a good opportunity to think about how you might handle the next downturn in the business cycle. The stock market was up today, and in light of the GDP report, you have to wonder about stock valuations; the earnings reports haven’t afforded much to cheer. Are you still buying or are you looking to sell into strength.

Since Q4 2011, the average peak-to-trough pull-back on the Dow has been roughly -6%, with no correction exceeding -10%. One may ascertain that a "buy-on-the-dip" mentality remains pervasive among equity investors. So why not add to long, risk-on positions once again? Could this pull-back be different? Aren't stocks "the only game in town" with the excessively accommodative Fed monetary policy?

And while you consider market risk, don’t forget the old idea of the best and worst six months in the stock market; we’re entering the worst six months by the way. The old adage "Sell in May and Go Away", warning investors of a seasonal decline in equities, is often attributed to summer vacations and decreased investment flows relative to winter months. According to the Stock Trader's Almanac, since 1950, the Dow Jones Industrial Average has had an average return of only 0.3% during the May-October period, compared with an average gain of 7.5% during the November-April period. 

When we look at the 13 cases since 2001, the strategy of selling out just before May would have given rise to successful trades in 9 cases, or about 70 % of the time. Moreover, we observe that the "Sell in May" strategy has not failed in two consecutive years since 1992-1993. Given that "Sell in May" failed in 2013, we estimate the odds for a seasonal decline are even higher for 2014. This is not a perfect indicator, but there are not perfect indicators. You have to think that anybody who doesn’t recognize the odds is just trying to sell you something.

And on the question of valuations, at 18 times forward earnings for the S&P 500 and 36 times forward earnings for the Nasdaq, US stocks are generally closer to the high end of their range; that seems a bit pricey compared to emerging markets with 12 times forward earnings. Still, somebody was buying today, at least enough to push the Dow to a record high close. Investor optimism for US stocks has been trending up since the end of 2011, reaching an extreme level in January. Of course that would be a contrary indicator. There are plenty of voices telling you to stay the course, or even buy, and then buy some more. I’m just saying it is important to consider the possibility of selling into strength.