Market Deception & The 2013 Exception
27 January 14 08:05 AM | Brian Dightman

The strong market performance of the S&P 500 (SPY), Nasdaq (QQQ) and Dow Jones Industrial Average (DIA) in 2013 was certainly a welcome surprise. Five years into this rally few expected to see the strongest market returns since 1997. Often it is the early years of a bull market that serve up the best returns. 2009 did not disappoint after the brutal 2008 decline. Subsequent years seemed to follow a pattern of positive but smaller returns until 2012 delivered another strong year only to be followed by the phenomenal returns of 2013. The market is constantly serving up deception and 2013 was no exception.

So what does 2014 have in store?

2013 finished well but the few trading days of the New Year have delivered a less than desirable start. January is going to be an important month to watch, perhaps more so than usual. Market returns from January are often a strong predictor of the outcome for the year.

On page 12 of the 2014 Stock Market Almanac we read, "Every down January on the S&P since 1950, without exception, preceded a new or extended bear market, a flat market, or a 10% correction". Page 42 of this year's issue goes on to catalogue the 24 instances that support their claim, 10 of which were listed as continued bear markets; a condition that cannot materialize in 2014 because the market is clearly in a 5 year uptrend. If the S&P experiences declines this January look for a new bear market, a flat market or a 10% correction to materialize.

You may find the "2014 Look Ahead" column in the January 6th issue of Investor's Business Daily (IBD) somewhat more helpful. Their data back to 1900 suggest only 7 times prior to 2012-2013 has the stock market delivered back-to-back accelerating double digit returns after a down year (The Nasdaq suffered a minor loss in 2011). The article goes on to explain what happened the following year and unfortunately the data is not encouraging. Only 1 year was positive and one year was flat, but 5 years saw declines. More troubling, 4 out of the 5 losses were steep - down 11%, 17%, 18% and 33%. If an ugly market does materialize IBD will quickly bring it to investors' attention in their "Big Picture" column, a daily read for me.

This January, perhaps more than some, it may pay to not only watch market action closely but too be prepared to take action. Given the propensity of this market to deceive I'm prepared for (but not expecting) another banner year in 2014. I will not be surprised if we first experience a brutal correction that convinces many the market is going much lower. That, I believe, is because so often market deception leads to market exceptions, despite all the statistical analysis that might suggest otherwise.

[IBD noted the following regarding the 2014 Look Ahead article I referenced: Data in the article were based on the Dow Jones industrial average for 1900-62, the S&P 500 for 1963-81 and the Nasdaq from 1982 to present.]

Dightman Capital Commentary Q1 2013
23 April 13 09:24 AM | Brian Dightman

The sell-off in gold over the last several days is a major development in global markets.  Since early October gold is down around 25%.  Ultimately this may turn out to be a buying opportunity but it is too early to tell.

It appears inflation expectations, one of the major drivers for the higher price of gold, is off the table for the time being.  Yes, The Fed has pumped a lot of money into major banks but that money has not found its way into the broader economy.  The velocity of money and the expansion of total credit remain at very low levels and until they move higher broad inflation is not likely to be problematic.  On the contrary, it is starting to look like we may be entering another deflationary phase where stocks and real estate prices could come under some pricing pressure.

I am not suggesting there is no inflation.  However, when comparing inflation measures overtime between the Consumer Price Index (CPI) and the GDP Deflator (GDP-D) the two indexes tend to measure very similar levels of inflation.  Right now they are suggesting we have low levels of broad inflation.

Inflation has also been held in check because each week reports confirm the economy is only growing slowly and the trend inconsistent.  We have yet to see the level of broad economic improvement needed for the economy to stand on its own.  In this environment even mild austerity could curtail future economic growth.  We know the Fed has renewed their concern about deflation because this Wednesday St. Louis Fed Chief Bullard stated The Fed may INCREASE the size of QE "to defend the inflation target from the low side."  Any weakness in stock or real estate prices may be limited by The Feds support of those markets.

Another place were inflation has been absent is input costs for corporations where prices have been growing only slightly, remain stable or are falling which helps to explain how companies continue to squeeze out profits.  It helps that consumers have been willing to maintain spending levels.  Eventually consumers spending may contract once the current round of home refinancing is over and credit card limits are reached.  That may have arrived.  Corporate earnings season, while just getting started, has been mixed.

The first quarter for 2013 was relatively smooth with only one point during the period where stocks fell under extensive selling pressure.  This caused the Global Growth strategies to move to a defensive posture to lock-in gains and keep losses small.  Stocks recovered quickly and the strategies were reinvested four trade days later.  At this stage of the recovery there may be value for risk-managed growth investors to overweight high-quality dividend paying U.S. companies.

Economic growth in the U.S. continues to deliver inconsistent results.  The general trend points to a generally improving economy but sudden weakness periodically gives pause to the sustainability of the ongoing recovery.  The real key to any pullback in stocks, given The Feds commitment to fighting deflation, is the health of corporate earnings.  If the market anticipates weakness going forward stock prices are likely to adjust downward despite Fed liquidity efforts.  The depth and duration, however, may be limited.  Bonds appear to be in a trading range and will likely stay there for the foreseeable future.

The outcome of all the market intervention looks set; either economic growth becomes self-supporting or the accumulating debt pile eventually breaks down.  The timeline, of course, is unknowable.  This is not your typical investment environment.  I will continue to do my best to deal with it effectively.

Ratio Analysis Shows International Stocks Strength
07 December 12 07:10 AM | Brian Dightman

For those investors who have been paying attention there has been a dramatic difference between international and U.S. stock returns during the recovery rally. It has been tough going for international investors, the iShares Brazil Fund (EWZ) is down over 9% YTD. In addition to other international struggles, China's slowdown and ongoing Eurozone debt issues may continue to be challenges for global investors. However, the underperformance of international stocks could eventually turn into an opportunity. As we come to the end of the year, international stocks are showing some signs of strength and deserve a closer look.

U.S. stocks have outpaced international stocks for most of the recovery rally by a factor of nearly two. If you compare the actual price action between the two securities listed below you will find broad U.S. stock indexes have delivered about twice the gains broad international stocks indexes did during the period. This is one of the reasons ratio and relative strength analysis can be helpful in making investment selections. This type of analysis would have kept an investor more heavily weighted, if not exclusively, in U.S. equities during most of the period.

A price ratio analysis compares the relative strength between two investments. In the chart below, the Vanguard Total Market Fund (VTI) is used to represent U.S. stocks and the Vanguard MSCI EAFE Fund (VEA) is used to represent international stocks. When the line is rising VTI is out outperforming and when it is falling VEA is outperforming. Other than a few brief periods, U.S. stocks have outperformed international stocks since the recovery rally of 2009.

When we reverse the order of VTI & VEA it makes it easier to identify the directional change. In the next chart VEA is outperforming VTI when the line is rising. We have seen this before; it is too early to tell if this will be sustained but it is worth noting and potentially taking some action.

We can perform the same ratio analysis to determine which regions are leading the international category.

Starting south of the boarder, Latin America 40 Index iShares (ILF) is struggling relative to its international peers.

Moving to Asia, the iShares MSCI All Country Asia ex-Japan (AAXJ) is showing some signs of leadership.

The iShares MSCI Pacific ex-Japan (EPP) is also showing some signs of leadership.

Across the Atlantic, we can see the Vanguard European Fund (VGK) was very strong late summer but has drifted sideways since.

The SPDR DJ International Real Estate Fund (RWX) is another international investment worth consideration.

As you can see from the chart above, the ratio was very strong mid-year but has started to weaken a bit recently. Ideally RWX will confirm its leadership by moving its ratio to new high ground in the coming weeks. RWX delivers the added feature of providing some exposure to Europe without owning the region individually. Approximately 30% of the fund's investments are located in Europe.

Investors would be wise to keep an eye on international investment categories. Improving economic data out of Asia and more stable debt markets in Europe appear to have helped investment performance in those regions. Should conditions continue to improve international investments may be poised to outperform as we move into 2013.

Disclosure: I am long AAXJ, RWX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Past performance does not guarantee future results. Investments are subject to risks including loss of principal. This presentation is for informational purposes only and is neither an offer to sell or buy any securities. A variety of sources we consider reliable have provided information for this presentation but we do not represent that the information is accurate or complete.

Internet Stocks Lead Market Higher
30 November 12 05:28 AM | Brian Dightman

After a pullback on the NASDAQ of nearly 11% markets have started to rally again.  If you used the pullback to generate cash, your next order of business is determining if the current rally is sustainable and where to invest next.

Rally attempts that are triggered during a holiday shortened week are suspect in my mind but we can't ignore the fact that markets changed direction last week, even if many traders were home watching their favorite football game while eating Thanksgiving leftovers.

From a broad market perspective there are some mildly bullish developments underway.  Other than a little bit of selling early in the week, most of the action has been to the upside.  Volume has not been as convincing as I would like, but that could still develop.  As of the close Thursday, the NASDAQ is up nearly 7% from mid-November lows.  Second, some leading stocks have broken out and others are setting up bases.  Granted, the current round of leading stocks are not the highest quality; that could also still develop.

The most challenging aspect of recent market action has been the impact of Fiscal Cliff progress or lack thereof.  Not exactly what you want driving the market, but that is what we have to navigate.  It is fair to say we have a broad market rally underway; now we need to look at specific investment opportunities.

During the pullback I built my watch list of stocks.  A couple of industry groups stood out to me and Internet stocks was one of them. If you have not noticed, Yahoo (YHOO), Facebook (FB), Ebay (EBAY) and others have nice rallies underway.  It may be late to pick-up shares of Yahoo; EBay and Facebook are somewhat less extended. Another way to participate in this segment of the market, especially given timing and the type of rally underway, is through the First Trust Internet ETF (FDN).  As you would expect, FDN has been performing in line with some of its top holdings, which include:

 

 

 

Together the four stocks above represent approximately 28% of FDN according to the First Trust website as of November 28th, 2012.  The top 10 positions represent approximately 52% of the fund and include: Priceline (PCLN), Yahoo (YHOO), Salesforce (CRM), Juniper (JNPR),Rackspace (RAX) and Netflix (NFLX) - overall some pretty decent companies.  Many investors may have opted to own the individual stocks which may explain why the AUM of FDN is below where it could be given the liquidity of its holdings.

It is a little disappointing the Internet segment isn't being led by younger companies and that may point to the maturity of the current rally.  FB is the only recent IPO of the group mentioned above.  LinkedIn (LNKD) is also included in FDN and appears to be taking a bit of a breather after a very successful IPO.

Internet leadership is a welcome element in the current rally but there are many reasons to be cautious here with the fiscal cliff banter an added element of uncertainty.  I am not optimistic the two sides will be able to agree.  The Dems want to focus on revenue and The GOP appear willing to concede to some degree on the issue but want spending addressed, which so far has gone unanswered.  Politicians love to give things away, even if they can't possibly pay for them. Both parties know the Debt Ceiling is going to be hit in early 2013, an added dynamic.

The best we can do is let the market set the direction, identify the stocks that are leading and implement the appropriate risk management for the macro environment.  Right now the market is suggesting that if we do get a Santa Claus Rally the Internet Sector is poised to deliver some Christmas gains.

Disclosure:  I am long FDN

Past performance does not guarantee future results.  Investments are subject to risks including loss of principal.  This presentation is for informational purposes only and is neither an offer to sell or buy any securities.  A variety of sources we consider reliable have provided information for this presentation but we do not represent that the information is accurate or complete.

Will The Rally Attempt Be Confirmed?
21 November 12 12:41 PM | Brian Dightman

A quick update on markets and the Global Growth strategies by Dightman Capital.

Tomorrow is Thanksgiving and I hope you are able to spend some quality time with your friends and family over a delicious Thanksgiving meal.  As a result of the holiday, this week's trading volume is going to be light.  Markets will be closed tomorrow and the trading session on Friday with be shortened.

Last Friday the market staged a rally attempt that could mark the end of the current correction.  A follow-through day will confirm the change in the stock market direction.  A follow-through confirmation sometime early next week is more likely, the Thanksgiving holiday will probably prevent a follow-though from happening this week due to lighter than normal trading volume.   As of mid-session trading today, the NASDAQ remains 8.5% below September highs, with the S&P 500 down 5.7%.

Leading stocks have been acting fairly well which improves the possibility we will see a follow-through to the upside.  However, trouble in the Eurozone and the U.S. Fiscal cliff discussions are strong headwinds for stocks to contend with.

At present the Dightman Capital Global Growth Strategies hold positions in the Absolute Return Fund, the Absolute Opportunity Fund and the iShares Investment Grade Corporate Bonds fund.  If market conditions improve the defensive moves made in mid-October generated cash that can now be deploy at potentially attractive entry points on some ETFs and stocks that look poised to advance.  If, on the other hand, markets respond negatively to developments out of Europe, the Middle East or fiscal cliff negotiations, we stand firmly in a defensive posture.

Looking Ahead To Q4 2012
03 October 12 08:32 AM | Brian Dightman

Precious metals have rallied in response to recent global monetary policy announcements.  There are practical limitations, like the debt ceiling limit in the U.S. (about to be reached again) which may create future challenges for The Fed; for now monetary authorities are fully committed to driving stock prices higher for the foreseeable future.

After lagging U.S. Stocks, international stocks may be in the early stages of a new uptrend.  The iShares MSCI Emerging Market Fund (EEM) traded as high as $50.19 in 2011.  Yesterday EEM closed at $41.80.

There remain many reasons to be cautious but global stocks continue to rally in response to policy announcements.  The U.S. and global economy remains soft and structural issues in the stock market, like leveraged banks and high frequency trading, remain reasons for concern.  We are also 3 ½ years into the recovery rally; stock rallies do not continue indefinitely.

I am going on the premise the current rally will continue but I am well aware that we may be in the final stage. There may be an opportunity to take advantage of the improving performance of international stocks and the pullback in the market overall.  I also recognize overall sentiment may be problematic.  From market commentator Bob Farrell's rule #9, "When all the experts and forecasts agree - something else is going to happen."

Current Investment Environment in 10 Sentences
25 September 12 01:22 PM | Brian Dightman

The Fed and ECB must be very concerned about the health of individual countries and the global economy to have embarked on open ended quantitative easing (QE) policies.

Central banks can expand their balance sheets significantly if Japan is any measure, with a debt to GDP ratio of approximately 200%.

At some point in their bond buying, perhaps many years from now, the Fed will stop buying bonds and this may be when long-bond rates will jump.

A cheaper Euro would help the periphery countries recover but policy makers appear unwilling to let it fall, perhaps due to all the bonds sitting on bank balances sheets.

As much as two-thirds of the stock trading on the NYSE and Nasdaq may come from automated systems, which the SEC is investigating, given the potential for aggravated market swings if the systems go haywire.

The Swiss National Bank's fight to devalue the Swiss Franc with their $635Bn economy against a $4Tn currency market is a great example of how ridiculous central bank "unlimited" policy announcements have become.

There is tremendous slack in the economy: production, wage growth, and employment are all well below optimal levels.

Quite remarkably, many corporations have been able to squeeze their operating environments through initiatives like closing factories, holding down wages and limiting investments to produce an impressive recovery in earnings for longer than many analysis expected.

The transportation industry is a good bellwether for the broad economy; I have posted commentary which may be helpful in gauging near-term activity.

Debt can be a powerful tool when it is deployed in a manner that generates a rate of return that exceeds its cost; watch GDP growth closely for clues about the return on investment from QE measures.

My Current Approach In One Paragraph

My full global growth strategies own primarily defensive and income producing equity investments.  Treasuries and gold offer some risk management.  Low volatility mutual funds add investment strategies to my approach.  I will be looking for opportunities to add more risk assets and reduce cash levels to position for a potentially prolonged QE stimulated rally in U.S. stocks.

Three Sentence Summary

  • The QE driven rally could continue for a considerable period.
  • The current environment may include opaque risks.
  • The present market appears over bought and susceptible to a pullback.

Let me know if you have any questions.  Be careful, pay attention and I am always available if you have questions.

Transports In Trouble
21 September 12 08:05 AM | Brian Dightman | 1 comment(s)

It did not take long for the transports to demonstrate weakness I wrote about on the 13th and 17th, despite a rally in the broader market.

The current market is not acting rationally in the face of deteriorating economics, poor earnings guidance and a rally up to QE3.  It appears the market is clinging to the open-ended monetary policies of the U.S. and Europe, which could drive the market high for much longer, and the earnings of a handful of corporations that are producing outstanding results.

Without the transports rallying along with the broader market, however, the likelihood stocks can continue the current rally is reduced.  The performance divergence seen below between the Transportation Index ($TRAN in red) and the Dow Jones Industrials ($INDU in blue), in combination with the overall economic environment, may be providing investors with an early warning to consider reduced risk levels.  We will have to wait and see if the market delivers a constructive pullback of 5-10% or something more severe; with serious economic headwinds and questionable market internals a pullback of some sort seems highly likely.

Weakness In Transports A Warning
17 September 12 12:45 PM | Brian Dightman | 1 comment(s)

I recently highlighted the Dow Transportation Index here; the following is an update.

Another troubling development with the transports is the convergence of moving averages.  The Dow Transports are in their 8th month of sideways trading.  When this happens moving averages come together.  In an appreciating market shorter-term moving averages stay above longer-term moving averages.  In the example below the 50-day and 200-day moving averages are sitting on top of each other indicating there has been little price advance in the last 200 & 50 days.

Using simple moving averages (where each price is weighted equally), the 50-day (blue line) has fallen below the 200-day (red line) moving average.  This is generally a bearish development.  If the 50 moves further below the 200 will start to slope down suggesting a major trend reversal.

When we look at the same moving averages based on exponential calculations (where recent prices are weighted more heavily) we notice that the 50-day (blue line) has formed a negative divergence, where the advance in August was not able to rise above the rise in July.

If we look at the same index over a different time frame we see there is still hope for the Transports.  On a weekly chart the index is trading right above the 50–day.  This is considered an important support level and if broken would also support a likely trend reversal.

If we step back further and look at the index from the start of the 2009 recovery rally we can see a very clear uptrend from 2009 through most of 2011, then a big sell-off.  Since the 2011 self-off the index has not been able to recover and continues to look like it is going to roll-over.

Weakness in the transports is not surprising; it is a direct result of weakness in the economy which data has been confirming for the last several months.

The Dow Theory - No Confirmation
13 September 12 10:07 AM | Brian Dightman | 2 comment(s)

I regularly monitor several investment theories in my work.  Lately I have been taking a closer look at The Dow Theory.  The Dow Theory is one of the oldest and most vetted investment theories in use today.  It also has a terrific track record.  You can find out more about the Dow Theory here.

The basic idea behind The Dow Theory is the relationship between industrial companies that make products and transport companies that ship both materials needed to make products and finished products to customers.

When the stock market has completed a contraction trend, like we experienced in early 2009, we would expect the transport index to confirm and even lead a move higher by the Dow Jones Industrial Average (DJIA).  Transports should lead because they are involved in the expansion well before final product sales by DJIA members.  This is exactly what we see below.  The green line ($TRAN), Transports, leads the blue line ($INDU) higher.  Recently we have seen a divergence.  The red circle on the chart below shows transports are now under performing the DJIA and have been since the start of the year.

Another important aspect of The Dow Theory is the concept of volume confirmation.  As an index rises, volume should hold fairly steady or even rise.  The chart below shows a closer look at the transports and DJIA performance over the last five months.

After the May sell-off, the DJIA (blue line) started to recover and ultimately reached a higher price level.  The transport index (green line) swung wildly during this period and has failed to confirm highs established earlier in the move.  September volume for the transports (bars at the bottom) has also failed to support the rapid price recovery over the last couple of weeks.

This may be telling investors all is not well with the underlying economy which is being confirmed by weak economic data.  At some point investors should expect the weakness to impact corporate earnings.  FedEx has already warned on next quarters earnings.  The Fed and other monetary authorities are in control at this point so keep in mind the market can rally further from here, but if global economies don't strengthen eventually monetary efforts may lose their effectiveness.

Gold Looks Ready To Shine
22 August 12 09:34 AM | Brian Dightman

After consolidating for nearly a year it looks like gold may attempt another rally.  During the pullback, the SPDR Gold Fund (GLD) found support just above $148 after closing as high as $184 during the summer of 2011.  Today GLD is trading around $159. 

There are several reasons GLD may be set to rally.  The European Central Bank (ECB) may be considering a proposal to keep yields down on bonds of sovereign debt by pledging to make unlimited purchases.  To qualify a sovereign would be require to meet their fiscal obligations, but as long as they are in good standing the ECB wants to put a mechanism in place that allows them to enter the market and purchase an unlimited amount of bonds.  This would allow newly issued bonds from having to support high interest rates.  Maintaining a cap on interest rates for new bonds is a necessary ingredient to keep the Eurozone stable.

In the U.S. the Fed has not signaled a definitive move beyond the extension to Operation Twist; they have signaled a willingness to monitor the situation and take action as necessary, meaning, QE3 of some sort is a real possibility if the economy remains weak and inflation tame.

Investors see all the central bank money printing as a potential for inflation.  Broad inflation seems to be in check currently (unless you wrote a check for college tuition this fall!) but if all of the monetary policy underway ultimately leads to economies that are humming again, the potential for demand to outstrip supply in a number of areas is very high, which could lead to widespread inflation.

In addition, we are coming into a strong season for gold.  The primary use of gold is the manufacture of jewelry.  The primary season runs from October to March.  If consumers are feeling good and spending more during the upcoming holiday season, especially in China and India, demand for gold could rise and push prices higher.

The difference between owning GLD and an index of gold mining stocks (GDX) comes down to volatility.  GDX is a much more volatile investment than straight exposure to GLD.  This can be attributed to several factors.  Miners are operating companies which require large capital outlays and subject to cyclical aspects of their industry.  Mining is also a speculative and high-risk business.  Gold miners are known to engage in hedging to moderate the value of their claims to changes in the price of gold.  While this should reduce volatility, at times it can increase it.

There is an advantage to investing in gold miners versus straight gold in terms of how gains are taxed.  Gold is consider a collectable by the IRS; gains in a taxable account are taxed at ordinary income rates, not long-term capital gain rates.  Gold minors are taxed like stocks and short term and long-term rates apply.  There are many other details to consider regarding tax elements so please research the subject further on the IRS.gov site or discuss the subject with your accountant.

In terms of other precious metals, silver (SLV) is the next logical choice.  I like the industrial exposure that silver benefits from, an additional source of demand.  Unfortunately, at this point in the economic recovery we are not seeing industrial production levels that would lead to an increase use of industrial metals.  The Powershares Base Metal Fund (DBB) is trading at a two year low and is not showing any signs of recovery.  If the economy strengthens, we should see it in prices for base metals.  Like gold miners, SLV is significantly more volatile than GLD.

Volatility can be a good thing in high conviction investments but I do not consider this a high conviction environment.  There are no clear signs inflation is on the horizon and central banks are still fighting a deflationary battle as individuals and governments try to trim debt.  Part of the driver in a GLD rally may be money moving from asset classes that have appreciated in the last year (Stocks, Real Estate, Bonds) into an asset that has decline in the last year and could offer protection if inflation materializes.  There is a lot of momentum investing in the current environment, which is what you would expect when the fundamentals are clouded.

Take a look at the chart below for a review of the price action for GLD over the last year.

Somewhat Defensively Positioned
10 August 12 08:51 AM | Brian Dightman

The global growth strategies managed by Dightman Capital continue to be somewhat defensively position but are participating in the current stock market rally.  At this point in the recovery I am focusing on playing it safe while maintaining some exposure to stocks.  The S&P 500 has rallied over 9% since the early June lows anticipating an effective policy response for Europe, reasonably good earnings on lowered expectations and fairly bullish forward guidance.  With the S&P 500 trading around 1400 it appears much of the near term outlook has been priced in.

I continue to monitor my investment model closely.  Defensive industries continue to outperform and trading volume remains light, both of which undermine the strength of the current rally.

As we move closer to September the stakes for investors will rise significantly.  German courts are set to make a ruling on the euro zone rescue fund, Greece will attempt to renegotiate its bailout which could cause it to ultimately leave the euro zone, and the ECB will assess the Spanish and Italian debt markets as they try and sell more bonds.  For two years the ECB has been inflating the euro zone life raft with just enough air to keep it above water but they have not been able to patch the slow leak.  Most economies in the region are either in or close to a recession which has caused the leak to grow.  It would appear all eyes are on central banks around the world to amass enough fire power to keep the euro zone from unraveling.  Estimates range but we are talking about a massive amount of money that would ultimately need to be paid back, which brings us to the more fundamental challenge, economic growth.  We are not seeing enough growth in Europe, or the U.S., to justify additional debt solutions.  Additionally, secular trends for the western world are not favorable.  This is an important subject and worthy of further investigation.  I strongly encourage clients to review the following detailed presentation by Jon Moynihan, of PA Consulting Group.  The trends he describes are clearly observable today.  The implications for U.S. investors are profound.

On a slightly different but related subject you can also find more information on the state of the U.S. consumer in the following commentary.

For astute investors, unique opportunities will be presented by the challenges the global economy currently faces.  I look forward to presenting more of those opportunities as conditions mature.  At present, I would suggest we are in a higher risk environment for most asset classes and more attractive entry points are likely to be presented in the next 6-18 months, perhaps sooner.

The Government Assisted Consumer/Corporation
08 August 12 09:53 AM | Brian Dightman | 1 comment(s)

The chart below tracks the number of non-farm employees in the U.S. since the late 30's.  As you would expect the number increases as the population grows and more people enter the workforce.  However, we can see since 2000 the number of employees in the U.S. has stagnated.  We have recovered some jobs from the 2008-09 recession, but the pace of new employee growth continues to be disappointing.

Click To Enlarge

Approximately 70% of the U.S. economy is driven by consumer consumption, so it is an important component to the health of our economy.  As the chart below illustrates, after a very brief pause in 2008-09, consumers remain in full consumption mode.

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With consumption levels continuing, it is somewhat surprising consumers have been able to pay down household credit but it remains well above the level from 2000, when the home equity ATM trend began.

Click To Enlarge

The net result for corporations has been higher profits after a very steep decline that started around the middle of the last decade.  Economies of scale, supply chain management, excess labor and government assistance have helped corporations nearly triple profits over the last decade.

Click To Enlarge

Some readers might wonder how consumers are able to continue spending at lofty levels when so many people remain un or under-employed.  This is where government assistance plays a roll.  Unemployment insurance, disability benefits, food stamps and other forms of transfer payments.  Some of these payments are designed to help stabilize the economy for short periods when it is experiencing a contraction.  The chart below tracks personal current transfer payments.

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The Bureau of Economic Analysis describes Personal Current Transfer Receipts as benefits received by persons for which no current services are performed.  They are payments by governments and business to individuals and nonprofit institutions serving individuals.  Government Social Benefits are defined as benefits from government social insurance funds and from certain other programs.

Using data (in billions of dollars, seasonally adjusted at annual rates) from the Bureau of Economic Analysis, the following figures were reported:

Q2 2012

Gross Personal Income                                        13,357.8

Personal Current Transfer Receipts                        2,356.4

Government Social Benefits To Persons                 2,310.6

Approximately 35% (2,356.4+2,310.6) of the income received in the U.S. were transfer payments.

Q2 2000

Gross Personal Income                                           8,506.6

Personal Current Transfer Receipts                          1,079.4

Government Social Benefits To Persons                   1,038.0

Approximately 25% (1,079.0+1,038.0) of the income received in the U.S. were transfer payments in 2000.

Q2 1960

Gross Personal Income                                              411.0

Personal Current Transfer Receipts                              25.3

Government Social Benefits To Persons                       24.0

50 years ago approximately 12% of the personal income received in the U.S. was based on transfer payments.  Today it represents over 1/3 of personal income.  It is very telling that 35% of the personal income received in the U.S. is based on some form of transfer payment, where no services were delivered by the recipient.  Social Security payments, which represented around 6% in 1960, have swelled to 17% in 2012.  From the Social Security Administration A SUMMARY OF THE 2012 ANNUAL REPORT:

Social Security's expenditures exceeded non-interest income in 2010 and 2011, the first such occurrences since 1983, and the Trustees estimate that these expenditures will remain greater than non-interest income throughout the 75-year projection period. The deficit of non-interest income relative to expenditures was about $49 billion in 2010 and $45 billion in 2011, and the Trustees project that it will average about $66 billion between 2012 and 2018 before rising steeply as the economy slows after the recovery is complete and the number of beneficiaries continues to grow at a substantially faster rate than the number of covered workers.

Investors wise to the structural challenges faced in the U.S. and secular shifts in the global economy over the decades ahead may be poised to benefit from the investment opportunities that will come from these changes.  However, there will be transitional times like we are currently experiencing where government policy press releases and government assisted profit growth are driving returns, not fundamentals. These are trends that are not sustainable over long periods.

Filed under:
Negative Yields & Higher Prices
13 July 12 08:59 AM | Brian Dightman

After six consecutive down days on the S&P 500, stocks are staging a bit of a rally today on bank earnings.  As we approach the mid-point in today's trading volume is a little light.  However, we have seen trading pick-up in the last hour recently so it is possible today may turn out to be an accumulation day.

The Producer Price Index (PPI) was released this morning and surprised the market with a higher reading for finished goods.  This development, should it continue, may make it more difficult for the Fed to continue quantitative easing policies.  Mr. Bernanke is scheduled to make two speeches next week so we may not have to wait long to find out if he is concerned about this development.  Input prices for intermediate and crude goods decreased in June, in line with industrial metal prices highlighted below.  It would appear something other than input prices is causing goods producers to raise prices.

On a more global theme, one of the bigger developments recently has been the price deterioration of the Euro as illustrated in the chart below.

With a focus on austerity, a slowing global economy, and debt issues in the region, the Euro may continue to come under pressure.

Back in the U.S., lower input prices in the PPI index suggest demand for basic metals has decreased.  Copper is considered one of the most widely used industrial metals.  The chart below shows price levels back to October lows.  Slowing global economies explain why copper (CU, grey line) demand has declined.  More broadly we can see the metal & mining industry (XME, blue line) following a similar pattern.  Interestingly, global stocks (VT, green line) have diverted from the price pattern exhibited last fall.  One possibility is the belief additional quantitative easing is on the way.

Often considered the smart money, investment grade U.S. bond investors have moved the asset class to new highs despite the June rally in global stocks (VT, green line) which often causes money to leave bonds.  With negative real yields (bond interest rate - inflation rate) on intermediate-term treasuries (IEF, gray line), it appears bond investors are willing to lose money on the investment relative to future purchasing power based on the current rate of inflation.  If you are earning 1.5% in interest on your bond investment but the price of items you purchase with the interest is rising by 2.0% annually, your purchasing power is being eroded.  At present bond investors do not appear concerned but it is not likely to continue.  Either inflation will come down or interest rates will rise.

With real bond yields in negative territory we may be nearing the bottom of how far bond interest rates can fall but little evidence exists indicating rates are likely to march higher anytime soon.  In Germany, BloombergBusiness week reported two-year yields fell as low as minus 0.052%. 

Gold is definitely not concerned about inflation at the moment.  When I last wrote about gold (GLD) I suggested the 50-day moving average was an important support level and if GLD failed to hold that level more selling may be on the way.  Since then GLD has come under additional selling pressure and is struggling to get above the 50-day moving average.  Going forward it will be interesting to see if the price of gold supports a deflationary or inflationary view.

With global demand soft and risks elevated, it appears monetary authorities hold the keys to a continued rally in stocks.  So far in the recovery rally they have not disappointed but the timing is less certain for the next move.

My approach at present is cautious and cashy given all the uncertainty with the global economy and heavy reliance on monetary policy.  Next week includes a busy calendar of earning and economic data which should provide more information on the depth of the current cyclical slowdown and near term prospects for growth.

Greek Debt & Global Stocks
07 March 12 07:09 AM | Brian Dightman

After a couple of good months Greek jitters returned and rattled markets.  International stocks experienced some of the biggest declines.  Developed market international (EFA) stocks fell -3.19% and emerging market (EEM) stocks declined -3.34%.  A majority of the developed country international stocks are located in Europe which helps explain why that asset class is currently underperforming.  Some emerging market countries, while more geographically dispersed, rely on exports to the European region for economic growth.  With many countries in the European region on the brink or in recession, Europeans may be spending less on foreign goods.

U.S. markets held up much better for the day and continue to lead global equities. 

  • S&P 500 stocks (SPY) fell -1.45%
  • NASDAQ 100 (QQQ) was down -.98%
  • Dow Jones Industrials (DIA) declined -1.52%
  • Small cap stocks (IWM) took the biggest hit of the group, down -1.99%

Stock market action again confirms the benefit of owning U.S. stocks over international stocks in the current environment.

Most of Tuesdays selling came from renewed trouble with Greek debt. 

A "Trillion Dollars", that is the rough estimate of the damage the Institute of International Finance suggested would be caused if private bond holders, some of whom are Greek pension funds, do not agree to take a nearly three-quarter loss on the value of their Greek debt.  A critical March 20th payment by Greece, if missed without an agreement in place, would constitute a hard default and trigger a series of consequences.  The manner in which the losses are being forced is a very interesting story and another example of how government can pick winners and losers.

A looming deadline this Thursday needs at least 75% of the bond holders to agree to take the nearly 75% loss which would allow collective action clauses (CACs) to be triggered forcing those bondholders who own bonds governed under Greek law to participate.  Some of the bonds in question are governed under Swiss and English law, further complicating the matter.  The legal action surrounding the Greek debt situation is a good reminder of the challenges that can face bond investors.

The market deserves a rest and additional selling may materialize.  Ideally the S&P 500 index won't fall below 1,290. A move down to that level would generate a 6% decline from the March 1st high, a reasonable pullback given the markets nearly 22% rise since October.  A better case scenario would be for the index to find support at its 50 day moving average above 1,300 but pullbacks in this market have not been as cooperative.

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