Alright, now I’m starting to get worried. No, not about the late Friday S&P downgrade of France, Austria and a host of lesser European countries’ sovereign debt. That was merely an acknowledgement of something that was obvious to any sentient being long before Friday. How in the world could France retain its AAA rating while the US, with complete control of the printing press for the world’s reserve currency warranted a AA? Say what you will about the fiscal mess in the US but we won’t be running out of dollars anytime soon. You might need a wheelbarrow full to buy a Happy Meal if the Fed keeps turning them out like pancakes at IHOP, but US Treasury holders will be paid. France, on the other hand, has about the same level of government debt relative to GDP as the US, a banking system loaded to the gills with PIIGS debt and the Germans in control of the ink for the Euro printing press. About the best thing that can be said about France is that with government spending over 50% of GDP, they have plenty to choose from when it comes to cutting spending.
No, what worries me is the recent – and extreme – rise in bullish sentiment among US investors. The American Association of Individual Investors weekly poll last week tallied 49.1% bulls and a mere 17.2% bears. For context, consider that just before the bottom in late September, those numbers were basically flipped (25% bulls & 48% bears). Meanwhile, according to the oxymoronically named publication Investors Intelligence, a majority of my advice giving brethren are now positive for the first time since last May. I would be remiss if I didn’t point out that last May wasn’t a particularly auspicious time to be a buyer of stocks; in fact it was pretty much the top of the market. So, now, after months of better than expected US economic data and a nearly 20% rally from the lows, investors – amateurs and pros alike – are bullish on stocks. If you’ve been reading these weekly scribblings for more than a week, you’ll know that makes me more than a little nervous.
Of course, putting investors on the couch is about as scientific today as the first time Dr. Freud asked a patient how they felt about their mother, so this doesn’t mean I’ll be heading into the office tomorrow to sell all our stocks. The consensus opinion can be right for a long time; I spent most of the late 90s arguing with the bulls. There is also the conundrum of mutual fund flows where individual investors continue to redeem stock funds and buy anything with bond or income in the name. While they may tell AAII they are bullish, their actions say something entirely different. Frankly, I’m more worried about the bond market than the stock market. The divergence between government bond yields, incoming economic data and stock prices will have to be resolved eventually. Either the bond market is right, the economic data is about to turn south and stocks are overpriced or the stock market is right, the data will continue to improve and bonds are overpriced. With all the money that has flowed into bond funds over the last year, it wouldn’t surprise me in the least if bonds take a big hit sometime in the near future. The market is a cruel beast and tends to inflict pain where it can get the biggest bang for the buck.
Stocks did continue their recent march higher last week with the S&P 500 up a bit less than 1%. Of course, S&P waited until after the market close to officially announce the European downgrades but based on the market action on the continent today, it doesn’t look like there will be much fallout. This move had been telegraphed for months and should be factored into current prices. I don’t see where much has changed. The European economy is slowing, Greece is still on the verge of default and the ECB is still supporting the Italian and Spanish bond markets, if sporadically. Europe needs the same thing this week as it did last week – a growth plan. There have been some tentative movements in that direction but much more is needed and it won’t be resolved anytime soon. In the meantime, US stock prices are dependent on the incoming US data.
Unfortunately, last week’s data included at least a couple of data points that are cause for concern. Retail sales have decelerated rapidly in the new year if Goldman and Redbook are right. Both reported a big drop in weekly same store sales and the year over year change is now back to the roughly 3% range that prevailed for most of last year. The growth in October and November appears to have been driven by a renewed enthusiasm for credit card usage. Consumer credit rose $20.4 billion in November led by non-revolving credit – mostly car sales – but also a non trivial jump in revolving credit of $5.6 billion. The official retail sales report for December showed a rise of a mere 0.1% and sales excluding autos and gasoline were flat so the gains of October and November were not sustained. Inventories, at least through November, continue to be in line with sales with the inventory/sales ratio steady at 1.27 for the fifth straight month.
Jobless claims jumped last week to 399k and that is also cause for concern. As I said repeatedly over the last two months, claims are hard to judge around the holidays and the recent drop needed to be confirmed in the new year. Last week did not do that but it isn’t time to panic just yet. Claims are traditionally highest at the beginning of the year so we need to see how this develops over the next few weeks. The trend is still down for now but it is tenuous and if claims continue to tick higher, we might have a big problem.
On the more positive side, import and export prices both fell in December, -0.1% and -0.5% respectively. The drop in import prices is likely due to the recently revived US dollar while export prices are more likely due to more subdued demand in Europe and Asia. Another positive report was the University of Michigan consumer sentiment survey which rebounded to 74. This is basically the same level as last January which isn’t bad considering the news of the last year.
I haven’t made any changes to our portfolios recently but I am monitoring some emerging trends. Oil prices have stayed around $100 but now the industrial metals are trying to put in bottoms. Copper, Nickel, Tin, Palladium and Platinum are all up on the year but with the exception of copper, remain in well defined downtrends. If this continues, it might mean renewed optimism about emerging markets which have also started the year on a positive note. Potentially confirming that are the emerging market currencies which also have moved higher with the flip of the calendar. Of course, higher commodity prices are not what the US or European economies need right now so while it might be okay for the emerging markets it isn’t good news for the global economy.
I’m also monitoring the bond markets closely. The very long end of the Treasury curve appears to have stalled a bit while the shorter maturities have continued to rally. Muni bonds have extended a rally that started late last year and are now extremely overbought. This would appear to be a manifestation of the fear that still permeates this market despite what investors are telling the pollsters. If we judge investors by their actions rather than their words, fear still rules this market. Whether it is warranted or not we’ll find out in the next few months. For now, I’m still sitting on a decent pile of cash waiting for more information.
For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Joe Calhoun can be reached at: firstname.lastname@example.org
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