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Posted By Jeb on January 18, 2010

General Market Comment:    January 18, 2010

 The market is closed in the U.S. on Monday for Martin Luther King Day.  The special election in Massachusetts for the senate seat formerly held by Ted Kennedy is shaping up to be a pivotal statement on the public’s support for the Obama administration’s policies.  A win by Republicans would be considered bullish. 

 The week will also include a heavy calendar of earnings announcements.  So far, the few earnings that were reported last week didn’t please the pundits.  The chart on the leading economic indicators as reported by the ECRI (Economic Cycle Research Institute) and updated through Jan. 8 shows that the economy is in fact undergoing a very robust symmetrical recovery.  This condition in the past has translated into equally robust earnings growth.  The ECRI data suggests the pundits will find the upcoming earnings reports to have more of the kind of growth they are looking for. 

As you consider the above chart note how the indicators tended to recover by as much or more in percentage terms as they fell going into recessionary periods.  The current recovery is exhibiting the quickest and the steepest recovery since the data series started in 1967.

 I also want to present an updated chart on the amount of money held in assets of zero maturity in the U.S. compared to the market value of the S&P 500.  MZM is now 97% of the market cap of the S&P 500.  There is $9.5 trillion sitting in cash and cash equivalents.  While this is not as extreme a percentage as last year when the market bottomed it remains far above the median level.  Despite the run up in the equity market and the recovering economy there remains about the same level of cash on the sidelines as at the peak in fear and uncertainty last year. 

The point of highlighting the MZM level is to say that there is ample upside to the stock market and the economy once that cash begins to be more productively invested in the real economy.

 I believe we may be beginning to see some evidence of that reinvestment of cash into the markets in the following chart on cumulative breadth in the S&P 500 as prepared by Bespoke Investment Group. 

A bear case against the market would need to see the breadth (i.e. the cumulative number of advancing vs. declining stocks) breaking down.  One can plainly see that is not occurring at this time. 

 So . . . we have a sufficient number of energetic and vocal skeptics to prop up the proverbial “wall of worry” needed to sustain a bull market, a looming pile of catalytic data in the form of Q4 earnings reports, plenty of cash still poorly invested and persistent internal market strength suggestive of more buyers than sellers . . . that all seems to suggest we have more risk to the upside in stock market values in the near term.

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Posted By Jeb on January 12, 2010

General Market Comment:    January 11, 2010

 The market had a solid opening week for 2010.  Market lore since 1950 is that the market goes on to rise for the year in over 86% of the cases if the first week is a gain.  Keep in mind that the first week was a loss in 2009 and in 2008 so this indicator is not entirely reliable.

 January is usually the best month of the year for the NASDAQ although it was down in both 2008 and 2009.  Strong earnings reports this month should allow the rally to continue in the near term.

 Earnings reports get kicked off this week however the largest number of reports will occur starting Jan. 18.  There are at least 8 broker sponsored investor conferences this week headlined by the JPMorgan Healthcare conference.  Needham also holds their popular growth stock conference this week.  We will see a flood of analyst reports over the next 30 days.

 We will keep our commentary short this week.  I will add color as we get further into the earnings season.  There has not been any material change to earnings estimates in recent days either in the broad market sense or in our names.

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Posted By Jeb on January 4, 2010

General Market Comment:    January 4, 2010

The fear du jour is appropriately that the recent run up in the stock market is due for a sharp correction.  There are some so bearish as to call for a retest of the deep lows of last March.  To be sure the surge in equities has been record breaking.  The NASDAQ rose 44% in 2009.  While that is impressive keep in mind that in 2003, the NASDAQ rose 52.5% in the twelve months ended September 2003.  It rose 56.8% in the twelve months ending December 1991 and it rose 86% in the twelve months ended June 1983.

What was common to all of the time frames?  The economy was recovering from a recession. 

So what happened afterwards?  That’s a loaded question obviously.  The market certainly corrected ultimately but I believe that we are still in front of the peak in the market compared to those prior periods.  I believe the case can be made we remain in the very early days of the economic recovery and should have prolonged period of equity value growth well into the second half of 2010.

 I say that for several reasons.

a)      we have not seen the peak in earnings growth.

b)      we have not seen a flattening in the yield curve.

c)      we have not seen the retail investors throw caution to the wind and pile into equities.

It is my intention to expand on each of those points in the coming days however suffice to say that the data at our doorstep this week and this month will serve to solidify the case for earnings and economic recovery.

One data point to keep in mind as the data piles up is the total disregard retail investors have shown to equities in the last 12 months.  Retail and institutional investors have poured an unprecedented $349 billion into bond mutual funds through the 11 months ended November.  At the same time they withdrew $4.7 billion from equity mutual funds.  They withdrew $30.2 billion from U.S. focused equity mutual funds.  This is beyond – silly – its insane. 

Keeping in mind the incredible bias for fixed income described above notice that when the NASDAQ appreciated 52.5% in the 2003 economic recovery there were INFLOWS of $151 billion into equity mutual funds.  Accordingly, the rise in the equity market in 2009 is even more remarkable in light of the absence of material capital inflows – that may change in 2010.  When and if the investing public begins to re-enter the equity market we will be able to expect a market value gearing of as much as 10X the amount of capital invested in stocks . . . “sweet”.

Here is a quote from a recent newsletter – ChangeWave Investing by Tobin Smith – that I felt does a good job framing the exquisitely contrarian circumstance we now have in the market.

It’s official — equities are dead. Bah! Humbug!  That proclamation was more or less issued in an article from Institutional Investor magazine. In it, the reporter argued that investors are “questioning the conventional wisdom that stocks outperform bonds. They’re systematically pulling back from equities, and Wall Street will never be the same. The equity party is over.”

Indeed, investors rattled by tumultuous stock market volatility have sought safer and more-consistent returns in fixed income — as well as in other alternatives, such as real estate and commodities . . . .

. . . Our take on equities is simple: If the financial media is ready to declare stocks dead — we want to own them. This is one of the most bullish signs we’ve seen in a long time and though it’s very unscientific, it’s nevertheless encouraging.

Who can ever forget BusinessWeek’s cover in 1979 when the magazine declared, “Death of Equities”? With Bloomberg now its owner, however, the publication isn’t likely to make the same mistake.

Equities may be down from their illustrious heights of the 1990s, but investors in the United States and around the globe will continue to want to own a piece of the action in what is still the world’s biggest and best economy.

That should do for now.

I suspect there will be some selling pressure in the coming days as gains from 2009 were pushed into a new tax year.  The selling will heralded with relief from the market technicians.  Earnings and improving macro data including potentially improved labor metrics as soon as this Friday should provide the foundation for the next leg up.

2010 will be a remarkable year.  Don’t allow your fears to overcome your logic.  Rational exposure to innovative growth companies such those followed by Aberdeen has a role in everyone’s portfolio.

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Posted By Jeb on December 14, 2009

General Market Comment:    December 14, 2009

 The holidays are a great time of the year to be thankful for what the current year has allowed us to achieve and to be hopeful about what the coming year will be.  2009 was a pivotal year for the market to say the least.  My intention here is to provide some context on the path of earnings, their outlook for 2010 and the implications for equity market.  I will be the first to admit there are many issues to consider as one looks forward to the coming year.  I only wish to isolate what the earnings outlook may mean for the level of the S&P 500 as a proxy for the overall equity market.

 First, have a look at the history of the S&P 500 “operating earnings” since 1988 to present.  I use operating earnings instead of “reported earnings” in an effort to knock off some of the blips created by write offs and other non-cash impacts.  The white circles are the earnings now estimated for Q4 2009 going out to Q4 2010.

Following the collapse in Q3 and Q4 2008 and in Q1 of 2009, earnings have made a remarkable recovery.  Expectations are that quarterly earnings will be back on the long term trend by Q2 of next year.  To say that the year over year comparisons will be forgiving is an understatement.

It is intuitively obvious that if earnings growth recovers, so do equity prices.  That is exactly what has happened this year.  As earnings growth has turned sequentially positive and is headed toward dramatically positive year over year growth, the S&P 500 has appreciated 22%.  My call is we are still in the early months of an earnings and equity value recovery similar to 2003-2004.

There are analysts who believe that the 2009 market recovery has been too strong and too fast.  They may be right but a look at the earnings spread and its impact on fair value suggests otherwise.  The present earnings yield (the reciprocal of the PE Ratio) for the S&P 500 is 154 basis points above the 10 year U.S. Treasury rate.  One can argue the Treasury rate is too low.  That is not the point here.  I like to say that we need to “live in the Land of IS” – not the maybe.  The spread of earnings yield over the 10 year Treasury is something we can measure discretely, is market based and has a good record of contributing to directionally correct models.  Here is a chart of the spread since 1988. 

When the spread is positive, equities tend to be undervalued.  When the spread is negative – equities tend to be overvalued.  Market history since 1988 tells us that a positive earnings yield spread, such as the 1.54% today, is consistent with a rising market 83% of the time in the following quarter and 90% of the time over the next 12 months.

 Some of you may recognize the following chart that illustrates the periods of over and undervaluation of the S&P 500 since 1970.  The market today is 30% UNDERVALUED by this measure.  In this case I use the 10 year Treasury yield as “cap rate” to infer a P/E ratio for the S&P 500.

The historical context of the above chart is framed by the data in the following table.  The S&P 500 has been 30% or more undervalued in 15 quarters since 1971.  The market has been up 12 months later in 86% of the cases by an average of 15.6%.  There have only been two instances – March 2009 and September 2009 – when the market was lower 12 months after being as much or more undervalued as today.  Clearly the performance of the market in 2009 may be considered an outlier.  No doubt the sample size is limited. 

 As you consider the likelihood of the market extending its recent run please consider the rarity of the current velocity of earnings recovery we have experienced and expect to experience in 2010.  As many of you have read in my prior notes we have seen record levels of positive earnings surprises this year.  The earnings for the S&P 500 are currently expected to rise nearly 46% in the current quarter over Q4 2008.  Earnings are expected to have peak year over year growth in Q3 of 2010 of approximately 80%.  We have only seen this type of growth twice in the last 90 years.  We saw 74% growth in Q3 1947 and 74% growth in Q1 1935.  The S&P 500 went on to rise 76% twelve months after the 1935 event but only rose 2.5% in the twelve months after the 1947 event.  The highest year over year growth we have seen in more modern times was 33.5% trailing 12 month earnings growth over the prior year in Q4 1988.  The market rose 27% in the following twelve months.

 Many of you may be very concerned about potential inflation, runaway fiscal deficits, a “weak” US$, Obamacare, Iranian nuclear threat, the ongoing war on terror, the impending increase in tax rates in 2011 . . . I could go on.  These are all legitimate concerns . . . but they don’t stop the economy here or globally.  Being concerned is advisable.  Frozen in the headlights is not.  The S&P 500 is up 66% from its low point in March.  The Aberdeen portfolio is up 94.5% on an equal weighted basis from its low point in November 2008.  The market is entering a period of unprecedented annual growth from a position of relative undervaluation.  2010 should see an extension of the impressive rally experienced in 2009 albeit with a risk of normal corrective action along the way.

 The downside in the near term is limited.  The upside is we may see a “melt up” of near historic proportions if the bond buyers and cash holders finally capitulate and move into equities over the next 90 to 120 days.

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Posted By Jeb on December 7, 2009

General Market Comment:    December 7, 2009

 There has been much to ponder over the last two weeks . . . Holiday retail sales, Dubai default, Bernanke confirmation hearings, a raft of economic news including the very surprising improvement in the November labor report.  The numbers I found the most intriguing had to do with the flow of investment funds.  As earnings have been beating estimates by record amounts and as the leading indicators have been improving sharply the “smart money” – i.e. hedge funds and other institutions who are managed by people paid for performance – have been moving aggressively into equities.  Meanwhile retail investors and managers who get paid on assets or just salaries – think pension fund managers – have been buying bonds in near record amounts.  Hmmm . . . who do you think might be right? Wrong?

 The retail investor is unfortunately virtually always a contrary indicator – he / she has an uncanny ability to do the wrong thing at the wrong time.  Today they are buying bond funds, gold, etc.  At the same moment they say inflation is a risk and yet buy the asset class most at risk if inflation is a problem – yikes!  Just think about it – $312 BILLION has gone into bond mutual funds in 2009 while $1.9 BILLION has been taken out of equity funds.  It is even worse for equity funds focused on U.S. investments – these funds have seen outflows of $21.4 BILLION.

The good news is that by historical standards the fact that retail investors have shunned the equity market in favor of bonds suggests we are not near the high in equity prices.  It may also suggest a significant inflow of funds into equities in early 2010 . . . that would be nice – eh?

 We remain in a historically benign time for the market.  December is typically the 2^nd best month of the year for the S&P 500.  It is the 3^rd best for the NASDAQ.  The downside in the near term is limited.  The upside is we may see a “melt up” of near historic proportions if the bond buyers finally capitulate and move into equities.

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Posted By Jeb on November 23, 2009

General Market Comment:    November 23, 2009

 While things should be relatively calm this week before Thanksgiving the government data mills will still spew data on Q3 GDP, Personal Income, Personal Spending, Durable Orders etc.  We will also get private sector updates on consumer confidence which of course the pundits will dissect for clues about the upcoming holiday shopping season.  All said, the tenor of the data, given what we already know from our sets of leading indicators should be one of recovery.

 Speaking of recovery, I have included some charts from Mark Perry’s Carpe Diem blog and the Calafia Beach Pundit – Scott Grannis, that not surprisingly speak to more evidence of recovering US and global markets.

 The first chart displays the number of shipping containers being handled in the Port of Los Angeles – the busiest container port in the US.  There is no surprise here – the number is going up and is no where near the highs in recent years past.

The second chart comes from Scott Grannis.  It gives us a view of the trend in global industrial production.  The thing to keep in mind is that these data sets are the quintessential “large numbers”.  They tend to change slope very infrequently.  When they do you can usually expect some durability in the direction of the change – it’s a momentum thing –eh?

 Given the global concert of central bank stimulus and fiscal spending, this upturn should persist for a time frame defined in years.

Of course if production is going up – so too should the prices of stuff used in production.  Indeed that is exactly what is occurring.  I wish to make a point that the increase in prices is not exclusively about the US Dollar – it is also, and perhaps more so, about a recovery in raw demand.

While one can become confused looking at stock charts or the changing levels of a particular stock index I find it useful to consider the aggregate value of markets.  Sometimes the “macro” numbers are better indicators for some of the “micro” components.  Mr. Grannis provided the following chart of the global equity market capitalization.  Ask any 10 year old what the direction of this chart is and they will innocently and accurately respond- “its going up Daddy” . . . sometimes it is just that simple.

The earnings season just ended illustrated that corporate America adapted well to the financial calamity of the “Great Recession”.  They produced outstanding earnings relative to estimates.  Logically, stock markets around the world have just experienced a price recovery of near historic proportions.  There are plenty of market players still in disbelief of the economic recovery and therefore the earnings recovery and therefore the equity price recovery . . . of well . . . we need pessimists as well as optimists.  The presence of bearish analysts and the earnestness of their arguments are healthy signs of early phases of recovery – not the middle and not the end.  Mind you – corrections of as much as 10% or more will be normal to expect.

 We are in a historically benign time for the market.  It only occasionally drops leading into Thanksgiving.  Remember that November is the best month of the year for the S&P 500 and the 2^nd best for the NASDAQ.  December is typically the 2^nd best month of the year for the S&P 500.  It is the 3^rd best for the NASDAQ.

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Posted By Jeb on November 16, 2009

General Market Comment:    November 16, 2009

 Earnings season is drawing to a close.  As of last week, 80% of the 463 S&P 500 companies who had reported beat earnings estimates. Here is an update of the number of companies beating the estimates as prepared by Thomson Reuters.  You will note how strong technology and healthcare – our areas of focus – performed.  Given that 93% of the companies have reported it is increasingly probable that Q3 will see the biggest margin of companies beating estimates on record.

 Of course analysts have been adjusting their estimates upward.  Here is what the next 12 months look like for the S&P 500 earnings as displayed by Yardeni.com.

The estimates for earnings over next 12 months are strongly suggesting operating earnings (adjusted for write offs etc.) will start to turn upward – and steeply at that.

 One newsletter I monitor is the Changewave letter by Toby Smith.  His chief asset is a network of several thousand active operators at technology companies that respond to periodic surveys on business conditions in the tech sector.  I have excerpted comments and a chart addressing the outlook for software purchasing.

 Our confidence is reinforced by the 90-day spending outlook for corporate software. It’s the best we’ve seen in two years and is occurring across most major software categories. . . . the results show corporations are more willing to spend on what is, in fact, largely discretionary for them . . . , the outlook for corporate software buying is improving. And that’s further confirmation that confidence is building about a return to sustainable economic growth

 Software is essential in our knowledge based economy.  We need to see the blue line head toward 20% in the next 90 days.  Fresh 2010 budgets should have plenty of room.

 The next chart comes from the The Liscio Report.  They track state sales tax revenue among other things to monitor the economy.  I particularly liked this view on the status commercial & industrial loans.

You can see that the survey of banks tightening or easing lending standards logically leads the trend in loan growth.  It would seem reasonable to expect banks will return to loan growth as we move into 2010.  This will coincide well with the anticipated profit recovery and need to restock inventories.  All of this will lead the recovery in employment.  It also suggests we remain in the early phase of stock market recovery.

 I suspect we will see even more economic data in the coming weeks that point to a confirmed view of economic recovery in 2010.  The pending holiday spending season will be watched closely.  Early signs are encouraging.  Favorable retail sales reports would be consistent with an early “January Effect” favoring small cap stock as we move into December.

 We are in a historically benign time for the market.  It only occasionally drops leading into Thanksgiving.  The strong earnings reports, upward tilting survey and other leading indicators and the mountain of cash remaining on the sidelines suggest this year shouldn’t be an outlier i.e. fall.   Remember that November is the best month of the year for the S&P 500 and the 2^nd best for the NASDAQ.

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Posted By Jeb on November 9, 2009

General Market Comment:    November 9, 2009

 The market had a nice rally last week following the closing of October with the worst week it had experienced the panic lows of last March.  There was the usual flow of warnings that maybe the huge market rally since those lows in March was about to end.  That is unlikely.  While the news on the unemployment rate reported on Friday sells more advertising it was news about the continuing surge in leading economic indicators, productivity and earnings that are the better barometers of the proximate move in the market.

 The move in the weekly leading economic indicators published by the ECRI (Eco. Cycle Research Inst.) remains breathtaking.  The increase over the last 6 months is in the 99.9^th percentile and has only been this close once in 1983.  Back then the economy was recovering from the twin recessions of the early 80’s and emerging from double digit inflation.  Friends – to state the obvious – these are “leading indicators” – the sharpest rise in these indicators occurs at the beginning of economic recovery and, logically enough, the beginning of sustained bullish phases in the stock market . . . that would mean – NOW – eh?

There was additional “leading” economic and market correlative data last week.  The ISM (Inst. for Supply Management) issued their monthly reports on manufacturing and non-manufacturing business activity.  No surprises – both reports pointed to continuing improvement.  I have chosen to focus on the new orders indicators below as they have good correlation with future job growth and earnings growth.  The following chart shows the diffusion index for both manufacturing and non-manufacturing sectors have turned sharply above the threshold of “50” signifying growth.

The following chart allows you to see that the ISM employment measure also turns up following an upturn in new orders – perfectly logical.

  For the doubters in the crowd I have also shown that actual reported persons employed do in fact grow following an upturn in “new orders” as reported by the ISM.  While it is undeniable that there are more people out of work today than anytime since the early 80’s, the ISM data suggests the situation is on the cusp of improvement.

Here is what the folks at ISI Group, run by Ed Hyman, recently displayed about the relationship of good ISM numbers and employment.  They refer to “PMI” which is stands for “purchasing managers index” and is a measure of overall activity, including the “new orders” data shown above.   The “PMI” index rose to 55.7 in October for the first time since June 2007.

 So friends . . . help looks to be on the way for the unemployed.  And, by the way, what’s good for the unemployed is obviously good for recovery of consumer demand and corporate earnings . . . it’s that “virtuous cycle” thing –eh? Speaking of which . . . let’s consider productivity for a moment.  Without growth in productivity you can’t get sustained GDP growth or earnings growth.  It follows that after businesses reduce employment in response to a shock to demand such as we experienced in 2008/2009 that they wait to return to prior levels of employment until – you guessed it – new orders pick up.  As orders rise and are filled by the reduced workforce productivity goes up and also profits.  Here is a picture of what was reported last week on the change in output per hour per person i.e. “productivity” courtesy of Brian Westbury at First Trust.

Brian stated the following . . . “ you have to go back almost 50 years to find two straight quarters where productivity has boomed as rapidly as it has in Q2/Q3 of 2009”.  A boost in productivity is always a precursor to a pick up in employment . . . and PROFITS.

 Here is a nifty chart by Ed Yardeni at Yardeni & Co. that takes the ISM new orders data series I have discussed and ties it to earnings growth as illustrated by the earnings of the S&P 500.  Ed combines the new orders data with the “prices” index also included in the ISM data.  It measures not just prices paid but is a barometer of prices received.  You don’t need to be a “quant” to see that new orders and prices lead earnings.  If new orders and prices are rising earnings are going to follow.

 Despite recently voiced concerns about the sustainability of the market rally and the surge in corporate earnings the data suggest we are entering a sweet spot in the economic recovery where earnings growth is strongest, most widely distributed and – interestingly – the least anticipated or reflected in Street estimates and management guidance.  With 88% of the S&P 500 companies already reported, 80% of the companies have beaten estimates.  This compares to the next highest percentage of companies beating estimates of 73% that occurred in Q2 09. 

 As always, you are welcome to disagree with any or all of the above sentiments.  The facts as I continue to see them still persuade me the market has more upside than downside.  Pullbacks in stocks where you have a competitive knowledge advantage should be exploited.

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Posted By Jeb on November 2, 2009

General Market Comment:    November 2, 2009

 So the history books will say that October was the first loss month in the market since the dreadful days of February 2009.  That said, 7 consecutive up months was quite an accomplishment.  In fact – we haven’t seen that many consecutive up months since 2003.  Back then – when we were also recovering from a deep bear market as I am sure you can only painfully remember – the market (NASDAQ in this example) went straight up from the end of January till the end of August – had a minor correction in September and then went on to rise another 4 straight months.  Of course now pundits far and wide are all asking if this means we are at a significant top or if October was only a pause in the market recovery.  My guess is markets don’t top when earnings are improving, when interest rates are not rising and when investors are yanking money out of equity mutual funds and buying bond funds instead.  Can there be a correction? Sure . . . but not a meaningful top.

 Here are some lines from Barron’s this weekend that capture the sentiment well, I have highlighted parts of interest . . .

 A Brutal Ending for a Bitter Month – Despite a lights-out GDP number, indexes suffer 4% selloff as other doubts pile up

October dealt investors their first monthly loss since February. Is the market now anticipating a departure of the very economic expansion that has just arrived? Traders believe — cheesy phrase alert! — “the trend is your friend until it hits a bend,” and after an almost non-stop seven-month climb, everyone is on prickly watch for the first sign of that turn.

There was unmistakable evidence the market was no longer as enamored by good news. Companies reporting better-than-expected profits barely eked out gains, while those missing their targets were socked. Selling was exacerbated by money managers anxious to protect their gains as their fiscal year drew to a close Oct. 30, and the impulse to “sell on the news” grew so pronounced some traders began to unload even before companies had reported said news.

  . . . personal savings jumped from $179 billion in 2006 to $450 billion this year. “Some of that savings is already being used to fuel a fresh round of spending,” he notes, and argues that the odds of a double-dip recession have shrunk to less than 20%.

 . . .  Over the past two months, investors have yanked roughly $19 billion from equity mutual funds, even as they plowed some $90 billion into bond funds. In fact, money has flowed out of stock funds in 2009, but the big grab of bonds has lowered yields and could hurt performance ahead. Says O’Rourke: “If people are long-term investors, as everyone says they are, they shouldn’t be net sellers of stocks in a year that could be a generational bottom for the market.”

 Now keep in mind that November is usually a very good month for stock markets.  In fact, it is historically the single strongest month of the year for the S&P 500 and the second best for the NASDAQ.  It also marks the beginning of the best string of months out of 12 months – namely Nov, Dec and Jan.

 So what could ruin the party?

 One item that could spoil the party would be a prospect for weakening earnings.  The markets would have to be discounting a sustained decline in earnings growth.  That isn’t happening at the moment.  The earnings season continues beat estimates . . . 80% of the 344 S&P 500 companies that have reported have beaten estimates.  There isn’t an apparent deterioration in that “beat” rate as now more than half of the S&P 500 have reported earnings.  The number of companies beating estimates as well as the margin by which they are beating estimates are setting records.  We have seen a similar outcome with our companies – they have all beaten estimates and raised their outlooks.

 What about rising interest rates?  There are some pundits pleading for the Fed to raise the Fed Funds rate.  Whether they should or shouldn’t is beyond the scope of thus note but I will like to point out that perhaps contrary to popular belief the markets in most cases rise – not fall – when the Fed raises rates – particularly when the Fed is just starting to raise rates.  You see – the economy is usually growing when rates rise.  You usually don’t get falling earnings and rising rates.

 Of course inflation could disrupt things.  There has been plenty of attention paid to rising commodity prices of late.  Clearly the government stimulus packages and the sharp increase in the monetary aggregates could point to a material uptick in inflation.  There are many purveyors of gold out there happy to accommodate your worst inflation fears – eh?  I won’t be able to persuade or dissuade any of you in this note about your views on inflation.  I only observe that the inflation metrics are – so far – benign.  That may all change but my sense is that will occur at a point when the stock markets are higher.

 Of course there will be gobs of news to digest this week not the least of which will include key gubernatorial elections in Virginia and New Jersey. 

 So there you have it . . . As always, you are welcome to disagree with any or all of the above sentiments.  The facts as I continue to see them still persuade me the market has more upside than downside.

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Posted By Jeb on October 26, 2009

General Market Comment:    October 26, 2009

 The earnings season continues beat estimates . . . 81% of the 199 S&P 500 companies that have reported have beaten estimates!  One would have easily bet that the percentage would have declined this week from the 79% reported last week.  The average percentage “beat” is up 18.1%.  This data is courtesy of Thomson Reuters. (by the way – Thomson mislabeled this table that I included in last week’s market comment as “Q2”)

Here is an update on the record of companies beating earnings estimates as provided once again from Bespoke Investment Management.  Their data encompasses all public companies and so it varies a bit from the Thomson data in the above table.  One can see that Q3 is a standout quarter so far.

Here is another one of their charts which is remarkable.  It overlays the net percentage of upside revisions to earning estimates on top of the S&P 500 price.  Earnings revisions are likely to incorporate increasing earnings as we proceed into Q4 if this picture portrays the true trend..

This is what Bespoke had to say about the two charts . . .

 In conclusion, the data shows that companies have been beating raised estimates and not lowered ones during this bull market, and the direction of quarterly “beat” rates is a trend that investors should definitely follow.

 The strength in earnings and the strength in the stock market is confounding many pundits.  After all, everyone knows that the U.S. consumer is broke and not consuming and therefore the global economy is doomed – just doomed . . . well, maybe not.

 My friends at GaveKal wrote an eloquent and short appraisal of the apparent contradiction of the rising stock market and lackluster consumer market which I include for you here.  I have highlighted comments that I liked the most.

       GaveKal         Checking the Boxes                        10-23-09

 The stream of strong results announced in the current earnings season is a reminder that we are in the midst of a very different type of recovery. In fact it is a rather old-fashioned recovery. We have come in the modern era to be accustomed to Keynesian cycles, in which consumption is the engine that drives economies back to growth after recession. This has been especially true in the past two decades, when nearly every tough patch in global output was cured with a widening of the US current account deficit as the US consumer came to the rescue every time. Yet, this time around, we have a recovery blooming even as the US current account deficit narrows, and while consumers nearly everywhere hunker down. In other words, this is an Austrian cycle, not a Keynesian one, and one where corporate profits, not consumption, will lead the way. Indeed, the companies that have weathered the storms of the past 18 months are emerging leaner and meaner, and ready to fight. They are enjoying a rebound in profits, and will need to re-invest those profits to stay ahead of the competition. As such, the next step in the recovery will be a classic capex-led restructuring, followed by a rise in employment and, later, a recovery in consumption. We are already seeing signs of this trend, with the rebounds in industrial production that are beginning to emerge across the global landscape, even as consumption data remains depressed. The US has seen three straight months of increases in industrial production, while China, for instance, just announced a +13.9% YoY jump in industrial production for September. And this is even before we have seen any meaningful restocking of inventories in the US….

 This change from a Keynesian to an Austrian cycle poses several challenges for investors. After all, indices in the past decade have been structured to reflect a Keynesian world, but portfolios should now be tilted towards an Austrian-cycle world. This is already starting to happen, as reflected in the strong performance of the tech sector, one that is capex-intensive and thus has tended to be a late-cycle performer in the recent consumption-led recoveries.

 We should also keep in mind the longer-term effects of the coming period of investment-led economic growth: increased efficiency. Tech investments always pay off in the long run by offering businesses and consumers cheaper and cheaper access to productivity-enhancing tools, gadgets and instruments. But tech is only one part of the current capex story. There will also be an immense amount of capital that will be flowing into alternative energy sources in the years ahead, as countries with dependencies on oil (e.g., the US) or other “climate-change” fuels such as coal (e.g., China) search for new technologies in wind, solar, nuclear and battery power, etc. The UN, for instance, has estimated that up to US$10 trillion in additional energy investments will have to be made over the next 20 years (see our write-up on p. 4 of the Oct. 13 Daily). The process will not only provide grist for the mill of a knowledge-based economy, but will lead to lower energy costs and greater energy efficiency (see Peak Demand?).

 In the past, “Austrian cycles” have often been associated with tough-luck, painful, even brutal economics. But this is a short-sighted characterization. Instead of a recovery led by overconsumption and mindless leverage by everyone from subprime-mortgage holders to investment banks that think they are hedge funds, we will have a recovery led by investments in the type of technologies that will make life smarter, cleaner and better. And this can only be good news.

 You are welcome to disagree with any or all of the above sentiments.  The facts as I continue to see them persuade me the market has more upside than downside.

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