In the lazy days of August, it’s easy to not do much. The market, while still trending up, is fairly lethargic: volume is low, indices see little movement. People are on vacation, and it’s easy to let our attention drift.
Still, wisdom dictates that it’s the best time to look at the porfolio and plan for the coming year. The September to November period has historically been a tough time for the markets. I used to wonder why, but it makes sense: it’s only human nature to take this time and look at the prospects for the next year. Our New Year might be in January, but psychologically, we still carry the “school year” starting in September.
The markets have had an amazing run. So much so that the S&P is trading at a recent PE high of 19x (based on diluted earnings from continuing operations), according to research firm Bespoke Investments. To give you perspective, the S&P’s PE has been as low as the 10x range in the last year , and hasn’t been as high as 19x since the 2002-2004 period.
The recent run has also driven out the short sellers in the market. Bespoke also calculates that short interest as a percentage of float for stocks in the S&P is now at 6.9%. The last time short interest was this low was in February 2007, before the recent market turmoil. Back in early August 2008, short interest was nearly 12%.
In sum, the market hasn’t been this bullish in a long time, and that alone is enough to bring out the contrarians and the bears. Despite the year recent year highs of the indices and the failure of bears to drive the market down, calls of froth in the market abound. Many are saying that we are topping.
The bears may very well be right, but I prefer to look at things in several different ways and see if I can come up with the same answer. The one thing that favors the bear argument: the market needs good, hard economic news to drive it higher. In recent months, we’ve had a rally based on cost cutting, “less bad” news and money on the sidelines playing catch-up. All of these market drivers will eventually exhaust themselves, and we will need new catalysts to keep things moving upward.
And what would those catalysts be? Earnings and industrial production statistics in Q3 would have to be favorable. At this point, that would mean revenue increases, as opposed to cost cutting. That in turn means somebody has to be spending. And thus the problem – who would that be? I think the consumer will be in hibernation for years to come. For the consumer, it’s like gaining weight: very easy to put on several pounds quickly; it takes a long time to take the weight off (believe me, I know). Another way to think of it – consumers are headed to Target and Wal-mart before they go to Saks, Nordstrom’s or Bloomingdale’s.
And what about businesses? It’s not clear by any means that they’re spending. The decline in unemployment would say that businesses are cutting less aggressively, but the fact remains, unemployment is still high. Last quarter’s earnings reports still showed year-over-year revenue declines for companies selling to businesses, so there’s no clear catalyst there. The only thing we can be sure of at this point is that costs have been cut and inventories are being worked off.
And finally, what about emerging markets and the much talked about China? Here, I think the talk of China as an engine of growth is overblown. China remains export dependent, and despite its high rate of growth, is not yet a consumer economy on the scale of anything in the West. True, China has been buying commodities, but it hasn’t been just for production. China has been a trader and a speculator, buying and stockpiling commodities when prices are low. That means China will eventually stop, or at least slow down purchases, especially as prices rise. I think that relying on China for further growth would be too much.
In commodities, there is a dynamic that could eventually support prices, and that’s basically the depletion of inventories. As we work off supply, we will eventually have a situation where we will have demand but limited supply, and that would drive prices up. I don’t think that would happen immediately, but markets could react to the expectation of this kind of condition within the next 3-6 months.
So today, we have a situation with a big rally behind us and no clear catalyst for a continued rally ahead of us. In the short term, we also have no clear catalyst that would drive us down, and given the amount of buying in recent months, coupled with very low short interest, it would take significant bad news to bring us down as well, in my opinion. The bears haven’t had much success in recent weeks, and that situation could continue.
Still, with lots of space below, the situation calls for caution. That means placing stops under stocks, buying puts, and/or taking profits. For the moment, caution is highly recommended.
0 comments:
Post a Comment