Dightman Capital - Global Market Monitor

Debt, Earnings & The Euro

Brian Dightman — Tue, 18 May 2010 17:46:00 GMT

Stock markets have come under pressure recently as concerns over debt levels of governments around the world take center stage. Policy makers are at a difficult juncture. They must support global economic growth or risk losing much-needed tax revenue, while at the same time figure out how to cut spending to curb soaring budgets. Arguments over this tradeoff are playing out in our own backyard as California attempts to address its $19 billion budget shortfall.

Cleary a cyclical business expansion is underway, which drove markets higher for most of 2009 and the start of 2010. However, we have to consider how much influence government stimulus is having on the expansion. With the Fed no longer purchasing mortgages and trillions already poured into the system, additional monetary and fiscal action by the U.S. government could ultimately unleash inflation. Most of the bailout funds to date are held on the balance sheets of banks and the Fed; not in the hands of consumers. Capital infusions to consumers and businesses, direct (think rebate checks) or indirect (think tax cuts and credits), would be a logical inflation trigger and one of the few policy actions left. An increase in taxes to raise revenues could be a drag on spending, which may hold down inflation, but could slow growth and negate the projected revenue increase.

Corporate earnings and sales growth, while somewhat improved, could suffer as cost cutting options become more limited and the influence of stimulus and bailouts spending on sales growth are reduced. U.S. companies have tightened their belts which shows up in high unemployment numbers. It is difficult to say how much impact stimulus and bailout money has had on increased sales, but is sure to have played a role. Taken in the context of valuations, using a Q1 2010 GAAP earnings estimate of $60.83 and a fair value P/E of 15, the S&P 500 should be trading at 912. The S&P 500 does not have to trade down to a fair value P/E, but today's P/E of 18.65 base on a recent level of 1,135 may be a little rich given the many global economic challenges currently faced.

The big question is this: Where does future growth come from? U.S. consumers have eliminated some debt, but a return to the purchasing patterns of the last couple of decades is unlikely especially since the home equity ATM is no longer open for business. Can we expect consumers in emerging countries to fill the gap? There are encouraging signs in consumer activity in emerging markets, but it is still too early to tell if consumers in Asia and other parts of the world will make up for reduced consumption by Americans. From a GDP perspective, according to the IMF the BRIC countries (Brazil, Russia, India, China), combined 2009 GDP totaled approximately $8.9 billion, well shy of the U.S. at $14.2 billion. U.S. consumption is estimated to represent approximately 70% of our GDP.

Regarding the European Union countries, they have serious issues in their common currency and run the risk of defections. After years of some countries ignoring deficit and debt provisions, it may be too late to save the Euro. Part of current market weakness is a vote of concern over the $1 trillion rescue package. We can expect big announcements out of the ECB and member countries in the near future.

All this said, the market is behaving badly and the risk of a major correction (even market dislocations) has increased, in my opinion.

Interest Rates Jump On Weak Treasury Auction

Brian Dightman — Wed, 24 Mar 2010 20:46:00 GMT

A sharp jump in interest rates took place today amid concerns over sovereign debt in Europe and a weak auction for U.S. Treasuries. Markets may be signaling concern over swelling government deficits, a problem that could get worse if the current economic recovery stalls because tax revenues are likely to fall.

U.S. interest rates remain at low levels but could advance quickly if U.S. Treasury auctions remain weak. Below is a look at yields for five (2.57%), ten (3.83%) and thirty (4.72%) year Treasuries.

It may be early to call a bottom in U.S. interest rates, but in other parts of the debt market complacency may be back. The spread between corporate investment grade bonds and corporate junk bonds has narrowed to around 3.9%. At the height of the credit crisis spreads widened to as much as 16%. Is an 8.36% yield (the 30-day SEC yield on HYG, a junk bond index ETF) high enough to compensate for default risk in this economic environment?

The bond market has known for some time the Fed would halt purchasing mortgage debt at the end of this month, which many commentators expect to cause mortgage rates to rise. Sovereign debt trouble has been in the headlines for months. What is new today is a weak Treasury auction. This could mark the beginning of a new direction for U.S. interest rates. It will be interesting to see the results of tomorrow's $32 billion auction in 7 year notes. And for the rest of the foreseeable future the U.S. will be going to the debt market to fund our spending. If higher interest rates accompany new U.S. debt issues, the amount of tax revenues going toward interest payments increases, decreasing our ability to pay down debt.

The dollar has held up in the latest chapter of the ongoing credit crisis. If global economic growth weakens, demand for dollars could decline and send the buck lower. A declining dollar combined with rising U.S. interest rates would present U.S. investors with a very challenging environment. It is a good time to pay attention to both interest rates and the dollar. Regardless of how market action unfolds, we are prepared at DCG to take a variety of actions to both protect and profit. Let us know if we can help.

Productivity Growth vs. Demand Growth

Brian Dightman — Wed, 30 Dec 2009 20:33:00 GMT

After a tremendous rally from lows hit in March, stock investors want to know if the rally will continue into 2010. Leading economic indicators produced by the private firm, Economic Cycle Research Institute (ECRI), suggest the economic expansion that started in the 2^nd quarter of 2009 will continue well into 2010. Their most recent comments suggest an improved job market may only be a few months away. We won't have to wait long for clues, several employment reports will be released in the first full week of January.

An improved job market could be a near-term catalyst to help stocks move to higher ground. But don't expect unemployment back in the 5-7% range anytime soon. If economic growth brings unemployment down by half a percentage point per year, a figure used by Lakshman Achuthan of ECRI as historically relevant going back many decades, strong employment numbers will not be reached until 2020. With the U.S. economy growing more slowly in recent decades, a lower unemployment number may be elusive for an even longer period of time.

Structural changes in the job market have seen some manufacturing jobs permanently eliminated, jobs that will not come back in a recovery, largely due to productivity increases. If productivity growth is higher than demand growth, the imbalance results in job losses unless structural changes are made to the employment market. Ironically, all the political talk about health care cost being too much of our GDP is exactly wrong under this scenario. Yes, we want our health care dollars to go as far as possible but for long-term replacement of manufacturing jobs industries like healthcare, education, and finance are logical areas for private market job expansion.

Lakshman expects more frequent recessions in the coming decade than we saw in the last two or three. Part of the reason has to do with the difficulty in smoothly withdrawing stimulus funds. If they are pulled back to quickly we could fall into another recession; to slowly and surging inflation may develop.

The business cycle expansion that started in Q2 2009 appears firmly rooted to carry us into at least the first half of 2010. This should bode well for stocks, but after an amazing run from 2009 lows it is difficult to gage how much more upside they may produce. Most of the rally took place before October. From March 9^th through September 30^th the S&P 500 gained 56%. From September 30^th through December 21^st it has gained only 5.4%. It looks like the S&P 500 will be up around 25% for 2009. The market consolidation over the last few months may ultimately turn out to be just what the market needs before moving higher in 2010.

As we close out 2009 another shift appears underway. After declining most of the year the U.S. dollar staged a sharp rally in December, up over 4%. Surprisingly the S&P 500 delivered gains (they have been inversely correlation since March) for the month but international stocks struggled. Both developed country and emerging market stocks show small declines. A strong dollar is often bearish for U.S. stocks. There are many inputs at work in the markets and as Wilbur Ross said recently on CNBC, "Now that the value of information has gotten to be about zero, there's an overload, and I think what's gonna be the end result is the value of expertise is gonna go to infinity. Because it is harder and harder for people to digest all these inputs, let alone make sense out of them, let alone translate them into investment decisions."

CLICK IMAGE FOR FULL VIEW

I remain cautiously optimistic about stock returns in the first half of 2010. The action of leading stocks has improved somewhat in December which improves the likelihood stocks will break out of the current trading range. I believe deflation has moved off the table for the time being and inflation is generally contained. At present stock investors appear willing to discount ongoing credit market issues and place more emphasis on somewhat improved economic measurements.

All of this is subject to change depending on fiscal and monetary policy action, not to mention potential credit market surprises. For now we can be grateful for the gains the market presented us with in 2009; Dightman Capital in on track to produce a very strong year for all three of our growth strategies.

Have a Wonderful New Year!

Credit & Real Estate Remain Key

Brian Dightman — Mon, 23 Nov 2009 16:07:00 GMT

After easily topping low Q3 earnings expectations, stocks are finding it difficult to advance from highs reached in October. Hesitation may be coming from new reports of continued struggles in the housing market where mortgage delinquencies continue to rise and new construction has slowed.

The credit market continues to remains tight and while problems in the commercial real estate market percolate. Commercial borrowers are finding it difficult to refinance loans and recent regulatory guidelines make it easier for banks to extend terms on many properties, potentially delaying foreclosures. Banks are also hesitant to foreclose on troubled properties because selling at current prices would require write-downs they don't want to realize. The key for commercial borrowers is leasing revenue, a function of lease prices and occupancy rates. As long as borrowers have the cash flow to continue servicing loans the market should remain somewhat stable but defaults have been rising as vacancies increase and rents fall.

As the economic recovery continues to unfold we can see how the performance of banks, commercial real estate, and home builders has transitioned from leading the market to lagging the market, possibly offering a sign of caution as we enter 2010.

The first chart below shows all three groups leading the S&P 500 from market lows in March up through the middle of October. Over the last month the tide has shifted. Commercial REITs have fallen to just match the performance of the S&P 500 and Banks and Builders are lagging by a significant margin.

NOTE: CLICK ON IMAGES FOR FULL VIEW

Given the role real estate and banking played in the market selloff in 2008 we would expect them to play a leading role if markets are going to advance from current levels.

We have also seen a shift in stock leadership. As the November rally kicked off the Dow Jones Industrial index has outpaced the S&P 500 potentially signaling a shift to larger, more stable companies. The transportation index has lagged as have small cap stocks, another disappointing development.

The balance of 2009 may see a continued rally in stocks as we enter into the holiday season, often credited with what has been called the "Santa Claus Rally", but the clouds may be forming for what could turn out to be very challenging start for stocks in 2010 unless more fundimental improvement of the economy is reported.

Secular Vs. Cyclical Markets

Brian Dightman — Tue, 22 Sep 2009 23:33:00 GMT

If you have been participating in my recent monthly online strategy updates (you can register for the next webinar here), you have heard me talk about secular and cyclical markets. If you are wondering what this means, I offer the following insight.

There is much debate on the subject and no definitive definition that I am aware of on the subject of secular markets. To use an analogy, I would compare the seasons of a year as secular and the weather patterns within each of those seasons as cyclical. Starting with a hot summer season you progress to a cold winter before heading back to a hot summer (secular), but throughout this major transition you have many short term temperature variations (cyclical). Some summers are unseasonably cold and the opposite can be true for winters. With economies and stock markets, think of the secular time frame as years/decades and the cyclical timeframe as quarters/years.

Secular markets are created from deeply rooted structural characteristics in an economy. I believe among other things, household debt, government fiscal condition (at all levels), and an aging population are a few examples of the structural characteristics of the current secular bear market in U.S. stocks.

Cyclical markets are predominantly influenced by the business cycle experiencing its own expansion and contraction within the secular environment. I believe the business cycle process is largely autonomous but can be influenced by government actions (interest rates, tax policy, stimulus, etc.). The business cycle is the natural ecosystem of capitalism at work where, as a simple example, businesses grow during periods of growth, over expand, start to struggle and are then forced to downsize, merge or go out of business.

The best example of a modern day secular bear market can be seen in Japan, the world's second largest economy. On New Year's Eve in 1989 the Nikkei 225 Index of Japanese stocks peaked at 38,915. Approximately 20 years later, it closed at 10,443, down over 70% from its peak as illustrated in the chart below.

Turning to the U.S., stocks have experienced big swings in value over the last ten years but have not been able to advance past the highs reached in 2000.

I try to approach the process of managing money from a risk management perspective that considers both the secular and cyclical environments. Right now I view the current environment as a secular bear, cyclical bull market. That means I am willing to position my strategies to make money in the near term, but ready to move defensively if I believe the rally has run its course and new trend down has started. Among other things, I believe household debt levels will need to be reduced, government finances will need to be improved, and lower U.S. consumptions levels (assuming higher saving rates materialize) will need to be replaced with higher consumption levels by foreigners before we can transition to a secular bull market.

Once we finally transition back to a secular bull market we should see long periods of stock market appreciation. From 1982 to 1999 the S&P 500 appreciated an eye popping 1,048% over 17 years. If we added in dividends it would be even higher!

I hope you found this information helpful. If you have any questions, feel free to let me know and I will do my best to answer them.

Rally Continues

Brian Dightman — Wed, 26 Aug 2009 20:58:00 GMT

The rally that started mid-July looked like it was about to end only a month later. On Monday, August 17^th, continued selling from the Friday before looked like the start of a correction. The S&P 500 was down 3.26% during the period on consecutive increases in volume. By the end of the week, however, the market reversed course again hitting new highs for the year on above average volume (which was subject to August options expiration). Since then the market has not been able to follow-through and trading looks weak. But the breakout last Friday was impressive and the bias for the time being is to the upside.

In terms of sector performance, Financials continued to lead but Technology underperformed and Consumer Discretionary came in just below the S&P 500 over the last 5 trading days. The S&P 500 is represented as the horizontal 0 baseline. Returns above the centerline have outperformed and those below have underperformed the S&P 500 during the period.

CLICK ON THE CHART TO ENLARGE

In terms of major U.S. markets, small cap companies have led over the last 5 days and the NASDAQ has underperformed the S&P 500.

CLICK ON THE CHART TO ENLARGE

Internationally, Germany and France are leading and significantly outperforming the S&P 500.

CLICK ON THE CHART TO ENLARGE

Stocks are overbought and could correct at anytime, but the likelihood there is more upside is very good over the months and quarters that follow.

Cyclical Bull, Secular Bear?

Brian Dightman — Mon, 20 Jul 2009 22:19:00 GMT

Just as stocks looked like they were going to move to the downside after a consolidation period in June and early July, stocks made a strong advance to the upside last week. On July 13 the S&P 500 advanced 2.5%; one of its strongest days in weeks. The following day the IBD 100 experienced its' fourth straight day of gains, up 1.2%. Big money (institutional investors) showed up on the 15th and pushed volume higher by roughly 40% from the previous day's level on one of the best days of the year for major stock indexes. The upside move by stocks coincides nicely with leading economic indicators produced by ERCI. The growth rate of their Weekly Leading Indicator for the U.S. has been improving for weeks and recently moved into positive territory.

With a major change in market character, this would be a good time to review how different investments are performing. Below I have listed the performance over the last 5 days (as of the close July 20th) of the ETFs currently held in accounts managed by Dightman Capital (see disclosure below).

AAXJ - Asia Ex. Japan (17.64%)
FGD - Global Select Dividend (14.66%)
EEM - Emerging Markets (11.66%)
BRF - Brazil Small Cap (10.45%)
HAO - China Small Cap (10.23%
QTEC - Technology (9.57%)
DBO - Oil Fund (9.17%)
QQQQ - Nasdaq 100 (6.55%)
SPY - S&P 500 (5.58%) Index Reference

Some of these ETFs have been recently added to my strategies and several were added earlier this year. For a more complete look at the performance of our strategies, please review our Composite Performance published on June 30^th.

The change in stock market character signals, in my opinion, the potential for a more constructive market environment for stock related investments in the near term. I am still overweight cash in my strategies but could become fully invested very quickly. With the improved action in stock markets combined with an improving economic environment, the likelihood we will move into a bull market increases. What you really need to know is what kind of bull market I am talking about.

I view bull and bear markets as cyclical or secular in nature. A secular market is considered one that is being driven by forces that could be in place for years. Within a secular market you will have cyclical markets associated with the expansion and contraction of the business cycle as well as changes in investor sentiment. It is my opinion the current secular state of the market is bearish. Viewed from a longer time period, broad indexes are trading today at the same level they were in the late 1990's. Stock indexes will need to appreciate considerably from current levels to move into secular bull market status.

Starting in the early 1980's, U.S. investors experienced two decades of a secular bull market with brief cyclical bear markets. This period marked one of the most significant advances in stock market history, which ended in early 2000. Since then the S&P 500 has not been able to advance beyond highs hit in 2000 and has experienced two brutal bear market declines. Within the current secular bear market, evidence is mounting that we started a cyclical bull market back in March. It could transition to a secular bull market but for now we need to use a shorter time frame and treat the current rally as cyclical in nature, in my opinion. Investors face many structural challenges that may prevent our economy from producing a transition from a secular bear to a secular bull market in the near term. I have written about some of these structural challenges in the past and will continue to share my opinion on the subject in the future. I believe keeping an eye on business cycle metrics as well as market price and volume action may prove to be especially helpful in the current environment.

For the moment it looks like stocks are poised to continue generating gains, led by emerging market countries and technology. Below is a chart of sector performance since the start of the consolidation phase (start of June through July 20^th)which shows the technology sector leading. This has been true of the broader indexes as well. From the March lows the Nasdaq, with a higher concentration of information technology companies, is up 50% while the S&P is up 40%.

Click on image for full view.

Nobody knows how long this cyclical bull market may last. I do believe I have the tools and processes necessary to monitor market and business cycle activity in an effort to manage my strategies. I am of the mind that we are in a cyclical bull market within a secular bear market. With that in mind, when/if this cyclical bull market ends, there might be prudent defensive action to initiate. If this is a risk management technique you would like applied to your investments, let me know, I would enjoy learing more about your investment management needs.

Disclosure: Strategies managed at Dightman Capital are currently invested in AAXJ, FGD, EEM, BRF, HAO, QTEC, DBO, QQQQ. This is not a complete list of all investments in the strategies managed by Dightman Capital.

Stock Market Trading Range Targets

Brian Dightman — Wed, 01 Jul 2009 18:44:00 GMT

More evidence of an improved economic environment was delivered last week when ECRI announced the growth rate of their leading economic indicator for the U.S. broke into positive territory delivering the highest weekly growth reading since August 10th, 2007. You can read their entire press release here.

Stocks ended the 2^nd quarter of 2009 stuck in a trading range that marked most of the action in May and June. Overall trading has been constructive; marked by higher highs and higher lows. Still, volume has been down on price advances, possibly indicating uncertainty by traders where there should be strength.

Individual stock leadership (as measured by Investor's Business Daily indexes) improved as the rally from March progressed, a promising development.

As long as SPY (S&P500 ETF) can hold above $87.50, the market rally will likely remain intact. The NASDAQ 100 (QQQQ) has shown relative strength during the current rally and small caps (IWM), to a lesser degree.

The Consumer Discretionary group (XLY) has hit support at $22 three times since May. Failure to hold this level may signal the start of a correction.

Selling pressure that materialized in June caused little damage to stocks overall. End of quarter window dressing by fund managers and low summertime volumes created some noise in the market, but overall stocks appear fairly healthy. Earnings over the next several weeks may provide stocks the catalyst they need for a move higher or lower.

The rally from March lows has been impressive. There are few reasons to add new positions while stocks remain in this trading range, in my opinion. If stocks break out higher (above $95 for SPY) or fall below support it may be a good time to add new positions. In terms of downside targets, I would not expect March lows to be hit or broken. I do believe a market correction would be healthy given the magnitude of gains that were created over the last few months. If the S&P 500 breaks May support at 880, using a Fibonanci Retracement Tool from the March lows to the June highs would suggest a pullback to 845, followed by 813 and 781 depending on the selling intensity. If you are looking to enter new positions based on a pullback, watch the index action at these levels.

Enjoy your 4^th of July holiday weekend!

Will Stock Market Gains Hold?

Brian Dightman — Tue, 16 Jun 2009 23:43:00 GMT

As the pattern of global economic data of less negative numbers continues, a shift may be taking place in asset pricing. Two possible reasons among many:

1) Asset prices are taking a break from the rapid appreciation realized since March

2) Economic data needs to move from less negative to positive as a catalyst for continued appreciation from current levels

In terms of asset prices, most of the month of June has been spent consolidating. Consolidation is a normal process and can be very bullish. Unfortunately, market action recently has led to price declines. My first course of action is to try and gauge whether we are going to experience a normal pullback or something more aggressive.

Commodity markets were a big part of the rally from March lows. Due to their sensitivity to the U.S. Dollar, we might be able to find near term price clues by comparing the two assets.

In the Chart below, the top window shows the daily price for the U.S. Dollar reversing up after the decline that started in mid-April. The bottom window shows the relative strength ratio between broad commodities (Powershares DB Commodity Index, DBC) and the U.S. Dollar ($USD). An upward sloping line indicates the first symbol is stronger than the second. The trend turned flat in early June and has a slight downward bias. A move past $82 on the U.S. Dollar may signal further weakness in commodities. So far oil has been able to hold most of its recent gains but strength in the dollar would be negative for crude oil prices.