Summer Break

I am travling back to China till July 2nd, will continue my posting upon return.

Nasdaq vs. Homebuilders vs. Oil

The price of oil has risen 729.58% from its low on November 19th, 2001 to its closing high of $138.54 on June 6th. When compared to the tech bubble of the '90s and the real estate bubble earlier this decade, oil's rally is just about in between the two.

As shown below, from the Nasdaq's significant bottom on June 24th, 1994 to its peak on March 10th, 2000, the index rallied 639% over 2,086 calendar days. From its bottom on March 14th, 2000 to its peak on July 20th, 2005, the S&P 1500 Homebuilder index rallied 839% over 1,954 calendar days. Surprisingly, oil's rally is now longer in duration than both the tech and real estate bubbles at 2,391 calendar days.

As we all know, the tech and real estate bubbles eventually burst and fell by as much as they rose. Their declines were very similar in both duration and size as well. While significant gains in any asset class carry their own set of circumstances and positive arguments, it's hard to look at this chart and not expect to see oil's red line come down significantly at some point. The demand argument for oil might be strong, but there were no shortage of "demand" arguments during prior bubbles either.

Shrinking US

Below we highlight a chart of world market cap since 2004 along with the percentage of world market cap that US stocks make up. The current value of stocks worldwide is just over $54 trillion according to Bloomberg. US market cap currently stands at a little more than $16 trillion, which puts it at 29.9% of world market cap. While 29.9% still puts the US at more than 3 times the market cap of the second biggest country, Japan, it is much lower than it was just a few years ago.

As shown in the chart, US market cap as a percentage of the world has steadily drifted lower over the last four years as global stocks have risen more and the dollar has declined in value. At the start of '04, the US made up nearly 45% of global market cap. Only time will tell if the world will get continue to get flatter or if the US will widen its market cap lead again.

Regarding Comments

I have received a few comments but for some reasons I couldn't reply in the comments section, anyway, thanks a lot for your compliments. As for where I get the articles, since I went to so many sites everyday it's hard to list all.

Briefing Speaking

1) The two most amazing things about the decline on Friday were that it was the worst Friday ever (down 45.80 in S&P futures) after an up Thursday, and that the Chairman, who talked at Harvard on Wednesday about the soundness of the economy, apparently didn't have the number in hand, as I have always treated his utterances as if he knows the next announcement at least three days in advance. The Kennedy School once bought a million + cache of vintage refreshments and presumably a similar effect must have caused the lapse. Of course, the teenage employment aspect is just one more fly in the ointment of the usual random numbers that greet the employment report, sure to be reversed on a statistical basis by the next random number which starts out with a strong bias from regression to mean effects for levels.

2) No wonder Visa and Master Card are up 100% over the last year. Apparently they're predicting 20% a year growth in credit card use as other countries and affinity groups increase their use of credit. Its now "debit or credit" rather than "cash or check." I was particularly interested in all the companies catering to the credit card companies as they would stand to grow as the epyphytes do on Google. Such companies as Total System Services and Heartland Payment Services, Fidelity National Information Services, which do the paperwork for the credit cards. The analysts make much of the fact that the credit card companies don't take the risk on their transactions but pass it on the banks. And certainly the paperwork companies would seem to be doubly removed. They seem like good buys relative to their growth prospects, and the adage that they do lead in the recessions and lead in the recoveries should be tested as should the similar phenonenon for brokerage companies. I was fortunate to be thrust into this line of thinking by having my credit card stolen when a park office would only issue me a $10 permit if I paid by credit card. The next day someone used my number for a four-figure purchase. Apparently thieves have cameras that can scan the front and back of credit cards. They have to go up against the security companies that can match every transaction at a cash register to a photo ID, even months later. The ingenuity of the credit card thieves, as underlined by a recent article in Boardroom Reports, is impressive.

Even more impressive to me was the followup that the biggest credit card company came up with. When I called, an agent offered me a big loan at 1.75%. After putting me through 15 minutes of identifcation they noted the fee was 3% sign-on. When I remarked that I would have appreciate they telling me that at the beginning (I never lose my temper, after 10,000+ competitive squash matches), they immediately dropped it to 1% and offered to qualify me for a bigger loan. They put me through a five-question credit scoring test based on cash flow and occupation ("speculator.. I mean, executive").

The flexibility they show in price discrimination, and reducing consumer surplus, and gaining a customer with a short term premium was impressive. Combined with their projected 20% a year growth, as "credit or debit" rather than "cash or check" becomes the new mantra, they seem to have many of the elements of a good business.

My very first post became my worst prediction for the market of the year, market did break out today, only the opposite direction of I predicted. Though I still think it's a range trading market, time will tell.

The market broke out today

This is the first post written by me. Because this is a new indicator I am studing and I would like to keep tracking it.

Market broke out today, not so much about the amplitute, but rather by the volume, and to be more accurate, by the distribution of volume, there were three big spike in volume in sp500, all of them happened during rising period. Also, biggger volume happened during closing and it was when the big up occured.

DOW 30 Underperform spx 500

After outperforming by a pretty large margin for most of the year, the Dow Jones Industrial Average is now underperforming the S&P 500. As shown below, the Dow 30 is now down 6.12% in 2008 versus -6.01% for the S&P 500. With AIG, MRK and GM all down more than 30% this year, and C and MSFT down more than 20%, it's not hard to see why the Dow is now struggling.

At the start of the year, not too many people thought they would be thanking Wal-Mart (WMT) for holding the index up.

Consumer Spending: The Reality of Zero

You can slice it, you can dice it. You can even massage it and look on the bright side. But you still can't get blood out of a stone or, it seems, inflation-adjusted increases in consumer spending.

Real personal consumption expenditures were flat in April, down from a slight 0.1% increase in March, the government reported today. Meanwhile, as our chart below shows, the longer-term trend isn't inspiring.

Looking at the three major components of consumer spending--durable goods, nondurable goods and services--doesn't inspire either. As the second chart below reminds, inflation-adjusted spending looks tired by several measures.

At least there's no mystery as to what ails Joe Sixpack's spending habits. Higher energy and food costs, a general if still modest rise in overall inflation, and housing and job stress are collectively taking their toll.

That leads to the question of whether the stress testing has legs? By my reckoning, there's good news and bad news. The good news: the economic slump may not deteriorate into a full-blown recession. Yesterday's modest upgrade of Q1 GDP's growth is one clue. The bad news: the "recovery," when it comes, won't seem much like a recovery.

Why? For now, we'll simply say that the economic chickens are returning home and they're of a mind to roost.

What moves stock market

It is often enlightening to see what moves the market. At various times in the business cycle the market responds differently. To look at this question a simple correlation study was performed using ETFs as surrogates for various macro variables.

Correlations with SPY for the last 95 days:

Oil USO 12%
Gold GLD -10
Bonds TLT -53
TNotes SHY -72
Euros FXE -15
Yen FXY -65
Fincls XLF 88

All of the above relationships are coincident and therefore not predictive. However it is interesting to note that gold is negatively correlated with stocks. On the other hand oil is positively correlated, which is somewhat unusual. The relationship between bonds and TNotes is negative and very strong. It seems that the recent fair weather in the stock market has been punctuated by recurring flight to quality squalls.

The dollar seems to be a significant factor as well. However it is notable that stocks are much more strongly impacted by the yen than the euro. Finally the financials are strongly and positively correlated with the market as one might expect.

Is Big Pharma Bad Medicine?

The big pharmaceutical companies may be doing wonders to help patients in poor health, but they sure aren’t doing much in the way of helping investors create healthy gains. In 2006, it looked like these stocks would finally pull out of their slump. But already in 2007, it appears as if their illness is far from cured. And here’s the incredible part – the bigger the company, the worse the performance.

To be fair, the market didn’t really have the best Q1 either. Even a small miracle today or later this week wouldn’t mean a whole lot as we wind down the calendar quarter. As it stands right now, the S&P 500 is only up by 0.86% year-to-date. We can’t expect these pharma stocks to go like gangbusters in a tepid environment. The problem is, it doesn’t appear as if these stocks even deserve to move higher, even if the market environment were better.

The wrench in the works – and it’s a big one – is simply how these major drug makers still look solid when you take a snapshot of the fundamentals. The average large-cap pharma stock’s current P/E of 16.8 is reasonable, even though this group can and has traded less expensively. Better still, the forward-looking P/E of the average drug manufacturer stock is 13.3 – cheap by anybody’s modern standard.

So why can’t these names get any traction in the marketplace? Perhaps investors are watching the numbers a little more closely than these companies realize.

Things Just Don’t Add Up

In the interest of a complete picture, not all the major drug makers are losing ground in terms of revenues and earnings. Enough are, though, to potentially spoil the whole batch.

Johnson and Johnson (NYSE: JNJ) is a good example of how the numbers just don’t seem to make sense. The current P/E of 16.08 is nice, and the forward-looking P/E of 14.13 is even better. But, the current numbers aren’t suggesting the same progress is in store. The quarterly earnings growth of 3.5% is essentially keeping pace with inflation, while revenue growth of 8.5% isn’t a whole lot prettier. That anticipated 12.1% improvement in the current P/E ratio is going to take a little more than very modest top and bottom line growth.

The Merck & Co. Inc. (NYSE: MRK) message is even more mixed. Based on current stock prices, they’re expecting their 2008 year-end P/E to be 15.67, versus the current P/E of 21.65. Great! But, how in the world is that going to happen when earnings are actually shrinking (year-over-year) by 57%, have fallen the last two calendar years, and have fallen for at least three consecutive quarters? Investors haven’t found an answer either…at least not yet. The stock seems to reflect it.

And if you work your way down the list of pharma stocks, more often than not you’ll find a comparable scenario – the current results don’t quite fit with where the company says they’re going.

If It’s Not One Thing It’s Another

If you’re looking for a little evidence that birds of a feather flock together, just take a look at Pfizer Inc. (NYSE: PFE). The stock is down slightly for the year, and has been falling ever since September – entirely missing the big 2006 year-end rally (a red flag in itself).

The unfortunate piece of the puzzle is this…the stock looks well undervalued, and actually appears to have a legitimate shot at trading at its forward-looking P/E of 10.95. That’s a relatively cheap stock, but not even as cheap as the current P/E of 9.6 (both are well under industry norms).

Obviously the Pfizer company is facing huge problems, right? Well, no - not really. Revenue growth is flat, and even taking out a major one-time boon to the bottom line in fiscal 2006, earnings were still 36% better last year than they were the year before. Even with a flat earnings forecast, the valuation remains surprisingly low.

Yet, even Pfizer can’t draw any real buying interest. If a good company’s stock can’t get traction right now, do the weak ones even have a prayer?

Bottom Line

Most individual investors – and most pros for that matter – tend to have more of a ‘show me’ attitude. As of right now, most pharma accompanies haven’t yet proven they’re going to be able to deliver on their lofty plans. In fact, most of the current numbers show anything but that.

One of the trickiest parts about being an investor is deciding whether or not a stock will trade at what the company thinks it’s worth, or if it’s going to trade at what most of the market thinks it’s going to be worth. In most cases, ‘the market’ is right. It doesn’t appear as if investors think much of the drug-makers right now….and, maybe they’re right.

Random thoughts

) With a good heart I mention, regardless of whether one was long or short, but from the standpoint of the dispassionate observer, the Osbornian man from Mars, or the O'Brianesque or Ferberesque all-seeing eye, it was beautiful the way this holiday week ended. Completely the opposite of the Easter holiday as is natural, and with total fright of a repeat of the French Bank inside trades on Washington's birthday. The memory of the terrible beginning of the year, and predictions of the Palindrome and Sornette, and the weekly old timer, and what happened in the last June to July comes to mind. Who could have the courage over the weekend except those who trade all markets without commissions and make money 95% of all days by marketmaking to the public, and enjoying borrowing costs of less than 2.5%. It's a perfect recap of the year, and a warning that only the strong could possibly withstand giving the public a chance to lose so much more than they have any right to lose. And today's action was so similar to the meaningless Employment number of January 3. With a rise by a gnat's earlash preceded by a run of two grand terribles. Everything is designed to deceive, and prevent the weak among the public from capturing the full differential of 6% earnings return plus 6% growth, compared to 3% on Treasuries. There were so many beautiful touches. The four down opens this week following five up opens last week. the down 50 this week in S&P after up 40 the previous week. the fake decline of the ten year below 115 and then back up to 116, a situation repeated endlessly over the last months, but each time with gusto and real sincerity. And the weak closes on Thursday and Friday followed by down down to surprise, discombobulate and ruin the vacation of all those who like to fade it.

2) The sight of a commercial space on the southeast corner of Fifty-third and First, long ago the Mayfair restaurant, not rented out for five years on the grounds that rents will go up and they should wait, reminds me of the builder who doesn't work overtime to get the rents, and those who buy the two year but not the 10 year, on the idea that rates could go up. But how much do they have to go up over the subsequent eight years to equal the total return of the 10 year, and, similarly, how much do the 10 years have to go up 10 years hence to equal the 30 year? It's terrible to see.

NYSE Short Interest Back Near Record Highs

Last night after the close, short interest figures for the New York Stock Exchange [NYSE] were released and showed that short sales as of May 15th rose 2.34% since the end of April. Even though the S&P 500 closed at its highest level since January, short bets remain near all-time highs. This is in contrast to October when short interest was declining leading up to the market's peak, and indicates that many investors are skeptical of the current rally.

click to enlarge


The table below lists the twenty non-Nasdaq stocks in the S&P 500 (Nasdaq short interest figures will be released on May 27th.) with the highest short interest as a percentage of float. Like last month, Consumer Discretionary and Financial stocks are well represented on the list of stocks most heavily shorted. The list of stocks on the list of least shorted come from various sectors. In fact, eight of the ten sectors are represented on this list (no Materials or Consumer Discretionary).

The Market

The market reminds me of some very creative people we all meet (people like Hobo) who always amaze you with new ideas and inventions at every clip. What it's been doing last few days has happened once in a saint's death. The gold, crude and euro:dollar all up 1 % or more in conjunction with a 1% decline in stocks. Never before, perhaps once, but never with up afternoon. Similarly today. What always amazes most is how fixed income can go up and down on statement of commissioners of authority, as if when they said they were vigilant on inflation that was bad for fixed income.

While we're at it, a paper in Nature says that there is a gene for leading a herd in humans, a long gene. Galton would have appreciated this, and looked for the comparable gene for being herded, a tendency he found particularly prevalent in oxen and humans. On a day like today with the market reacting to minutes of several weeks ago, with much new data in markets, and announcements by leaders of the pack, one would have hoped that the presumably short gene for sheep-like behavior would not have manifested itself in so many breaks below round numbers and trillions of wealth temporarily lost, with the herded ready to transfer so much wool and mutton to the big leaders who can borrow freely at the discount rate from their future colleagues.

P/E Divergence Between Growth and Value Stocks: The Wrong Way

Recently, growth and value stocks have seen a big divergence in valuations. One index has an as-reported P/E ratio of 33.66, while the other is at 18.92. The only problem is that it's the value stocks that have the 33.6 P/E, while the growth stocks have the 18.9 P/E.

Below we highlight a historical chart of trailing 12-month P/E ratios for the S&P 500 Growth and Value indices. As shown, the Value P/E has spiked significantly in recent months, as supposed value names that typically pay high dividends (financials, etc.) have seen a big drop in earnings.

This isn't the first time the divergence has happened, however. After growth valuations spiked during the tech bubble, value stocks followed with their own surge in P/E ratios in late '01 and '02. Ironically, growth stocks have held their value much better than value stocks have in 2008.

The Drifter

Housing drop

Subprime flop

Credit crunch

Belly ups

Bail outs

Fed puts

No recession

Jobs in session

GDP

Low inflation

High oil

Faked them out

Stocks up

Percentage of Stocks Above 50-Day Moving Averages

Currently, 77% of stocks in the S&P 500 are trading above their 50-day moving averages. As shown in the one-year chart of this indicator below, 77% is an overbought level and it usually doesn't last long without seeing a pullback.

On a sector basis, Energy and Telecom top the list with 89% of stocks trading above their 50-days. Technology is at 87% and just broke to a new one-year high. Healthcare and Consumer Staples currently have the lowest percentage of stocks above their 50-days, as investors have shunned defensive sectors over the last month or so.

Gray Man

The legend is that before big hurricanes and natural devastation in the Carolinas, a gray man appears . What is the gray man that appears before big devastations in the markets? I propose that yields in bonds going up a plethora is one such gray man, a throwback to the bond vigilantes, and there are stock vigilantes and gold vigilantes. The whole subject calls for quantification as I return from the Carolinas.

Economist Recession Odds Tick Lower

Bloomberg's monthly survey of economists was released on Friday, and the collective odds for a recession over the next 12 months dropped to 55% from 70% in April. Below we provide a chart of recession odds from the monthly Bloomberg economist survey versus the Intrade contract for a recession in 2008 going back to the start of the year.

The Intrade contract most recently traded at 27.3, which is down from a reading of 72.9 last month. It's noteworthy that the recession has to occur in 2008 for the Intrade contract, while it's over the next 12 months for the economist survey. But it still highlights that economists and traders have both become more skeptical of an actual recession, with traders more so than economists.

Twelve O’clock and All’s Well”

For the week the Dow lost -2.39%, the S&P 500 -1.81%, Nasdaq -1.27%, and the Russell 2000 -0.78%. The S&P 500 chart from my previous post does not need updating because on Fri the market did not move much. Markets around the world also offered dismal weekly returns with the one key exception in Russia which soared +9%. The top performing sectors this week will not be of any major surprise - oil & gas, metals & minerals, precious metals, specialty chemicals, and basic materials. The worst performers were airlines, generic drugs, regional banks, investment brokers, education & training services, department stores, and insurance.
The Treasury bond market is very close to completing a major reversal, and that would signal higher rates over the next 3 - 6 months in S&P analysts view. The 10-year Treasury yield is close to breaking key support at 3.96%, and if it does, a major double bottom in yields will be complete. Yields could then jump to the 4.4% to 4.5% range.

Commodities are still hot these days, and that will influence inflation and make life miserable for the equity investor, unless he/she is in commodity-related stocks. However, there are always exceptions to the rule and certain stocks, sectors will thrive regardless of the general economic pic.

The Baltic Dry Index is up 82% since bottoming in late January, which might be a sign that the global economic environment is not faring as poorly as many think.