Monthly Archives: September 2009

25th September Are institutional investors selling stocks?

Stock markets around the World have looked decidedly skittish in the last two days. Specifically we have witnessed several large end of day sell-offs in major indices. The first occurred on Wednesday in the US and was followed by a similar Europe-wide move yesterday. Consecutive sell-offs of this sort usually are an indicator that institutional investors are reducing global exposure to stock markets.

The timing of large-scale selling is particularly important and this time is no exception.

On Wednesday the Federal Open Markets Committee (FOMC) gave their latest decision on US interest rates. As expected they kept them on hold, but it was the accompanying note that caused market concern. Specifically it became clear that the Fed does not have a clear exit strategy for its fiscal stimulus measures.

At the start of the year and during the debate over the Public Private Investment Programme (PPIP), Fed-Chairman, Ben Bernanke, made a clear commitment that fiscal stimulus would only be required in the US until September 2009. With this in mind it would not have been too unreasonable to have expected the Fed to take the opportunity at its September meeting to announce its plans for unwinding this strategy.

I am concerned at the absence of such an announcement as it leads me to one of two conclusions. Either there is a recognition at higher levels that the fiscal stimulus has not worked and there is a need for more or the scale of the grand economic experiment of the last two years is so great that policy makers are still overwhelmed by it and cannot see a way out.

Whatever the case, economies are still desperately in need of strong leadership.

Seductive headlines and data sets over the summer have created an optimistic view that the worst is behind us. While I don’t agree with this, I am even more convinced that the last thing the economy can cope with is lethargy at the top. Until fiscal stimulus is withdrawn we are living in economic limbo. The withdrawal of fiscal stimulus is going to have to be both well-timed and managed in an orderly fashion. Given the sheer volume of liquidity pumped into global markets by central banks we cannot underestimate the complexity of this task.

It now falls on the shoulders of the architects of these fiscal initiatives to demonstrate to markets that they are up to the challenge. Failure to do so could well prove to be the catalyst of further substantial stock market declines.

If we see another end of day sell-off today then the signs are not looking good.

22nd September Does retail investor optimism signal a top?

I was a bit preoccupied with the state of the Nation’s finances on Saturday, but there was an extremely interesting article on the front of Saturday’s FT. Titled “Surge in trading by small investors“, this was the sort of headline I had been waiting for before shorting the market.

Regular readers will know that I have not been able to understand what has sustained this rally. The outlook is highly uncertain (especially while fiscal stimulus measures remain in place), P/E valuations are extremely high, volume has been light and other technical indicators are signalling the likelihood of a correction. However in spite of all of this stocks have continued to rise.

Following the basic line of thought that retail investors are usually the last to act in a market move, I did a bit more digging around last night. I went to the website of the American Association of Individual Investors and had a look at their regular sentiment survey. In recent weeks the bullish to bearish ratio has moved in favour of bullish retail investor sentiment.

As warning signs go these sort of news items can provide excellent indicators of trend reversals.

There is one other factor, which makes me more sure that a correction is due. Best explained in this article, this rally is only the sixth in the last 100 years of a similar magnitude. When we consider 4 of the six occurred during the last two worst bear markets (1929, 1932, 1933 & 1974) it is very difficult not to measure the historical comparison against our current situation.

With earnings season approaching, we are now entering the critical 6 – 8 week window prior to this, when stocks start to move as institutional investors weigh up the likelihood of companies beating or missing estimates.

The more I look at it the more certain I am that the next significant move in markets is going to be down. I just see too much pressure being applied to stocks. However before I do anything I am going to keep a very close eye on market moves this week and pay special attention to volume.

I am concerned that my view might be completely out of step with the “reality” of market sentiment. The FTSE 100 has broken through 5,000 and the Dow looks like it might break 10,000. Normally one would expect that this would be the signal for further gains. Given that emotion and fiscal stimulus have been driving a lot of this market, then further gains could be on the cards.

19th September The real “tough truth” hits us

After the empty rhetoric about hard choices earlier in the week, we were hit yesterday with the starkest of reminders of the awful predicament we find ourselves in.

By any measure the latest announcement on the state of public sector finances was horrendous. Borrowing hit a record £16bn for August this year versus £9.9 billion the year before. This 62% increase in the year on year figure was bad in itself, but what was most telling was that this was coupled with a relatively paltry 5.3% increase in actual spending. Remember this Government, which is “investing” in public services, promised a 7.4% increase in the Budget.

This is all deeply concerning and I fear can lead us to several unpleasant conclusions;

1) Tax revenues are declining worse than forecast. This means the Government is desperately trying to avoid making cuts before the next election through increasing the deficit.

2) Effots to “spend our way out” of recesssion are not working. We clearly lack the financial capacity to pursue this strategy effectively. The Government has undershot its self-imposed target of spending increases by nearly a 1/3.

3) The Chancellor’s forecasts are now looking highly optimistic. This has very serious long term implications for our nation’s ability to repay the debt and to start afresh.

Faced with such appalling data the only honourable course of action for Labour is surely to call a snap autumn election. Of course there is no chance of this happening, but the question is can we really afford another 9 months (assuming a May election) of this economic vandalism?

I fear not.

The longer spending is underpinned by the ever-expanding deficit the harder and more prolonged all efforts for resolving this mess will become. This is really not rocket science. It is simple logic.

Judging by the coverage in the FT it would appear that the official press release for these figures tried to offer a glimmer of light at the end of the tunnel. Specifically the article mentions the rises in stamp duty, the reintroduction of the 17.5% VAT band and “gradual economic recovery” as providing the basis for relief to the exchequer next year.

I still believe it is far from clear that recovery is taking place. It can’t be until fiscal stimulus measures are removed globally. So with this outlook I am convinced that the only prudent course of action is to start making cuts in public spending now or at the very least let the nation decide on the course of action.

Neither are likely to happen and I find myself really hoping that I am wrong on how the next decade is shaping up for this country.

16th September The tough truth about the hard choices?

Over the last few days I have been watching with interest announcements from this year’s Trade Union Congress. In recent years about the only memorable event to occur at the TUC was Tony Blair’s much-praised farewell speech. Other than the odd annoying postal or rail strike our lives are rarely affected by union action. In fact the most successful strike I can think of, which had a genuine impact of my life, was the fuel protest at the turn of the Century and that wasn’t even officially organised by unions.

However this happy detente in labour relations looks set to end abruptly in 2010.

The militant tone of this year’s Congress cannot be overlooked. While on the one hand claiming that the “recession is not over” the TUC also backed a plan for industrial action in the event of public sector cuts. Slashing the deficit is going to be the defining issue of the next Government. Achieving this without widespread social unrest looks a distant dream.

I can understand the arguments for “spending our way out of a recession” but this overlooks the critical fact that going into 2007 our nation was already taxed to the hilt and the deficit had already spun out of control. Since the bailout of the banks this precarious situation has worsened substantially and that is not even taking into account plummeting tax revenues thanks to rising unemployment and terrible trading conditions for companies.

Given that we are now living through perhaps the greatest economic experiment ever attempted, the total absence of slack in our economy means we are all going to have to make sacrifices to give the measures attempted any chance of success. The alternative is unthinkable.

And it is with this in mind that I was encouraged by some of the headlines I caught about Gordon Brown’s speech at the Congress.

The statement “the tough truth about the hard choices” sounded like even our Prime Minister, who has always appeared to be ideologically-fixated on hosing the public sector with cash, had come to recognise the perils we face after a decade of profligate Government.

Then I read his speech.

The headlines were great, but the detail was a great disappointment.

Think about Obama’s address to Congress last week. It is certainly true that Obama has an incredible flair for oratory, but when he spelled out his vision for healthcare reform in the States, no-one was left in any doubt as to the direction he planned to take.

Brown’s speech in contrast was contradictory at best and downright misleading at worst.

He claimed that thanks to the initiatives this Government has employed “500,000 jobs had been saved” and “22million people have benefited from tax changes”. The basis for these claims was not offered and, let’s face it, their credibility is questionable.

When it came to talking about specific measures to combat the recession, the best he could muster were 21,000 apprenticeships in the public sector, 20,000 new houses and 55,000 young people guaranteed university or work placements. With unemployment now at 2.47million and likely to continue to rise well into next year these stimulus measures are paltry at best and certainly do not justify the size of our national debt.

Moving onto tax rises, Brown announced some very specific measures he will introduce if he gets the chance. These include a 0.5% rise in National insurance, a 50p tax band for high earners as well as a reduction in tax relief for this group. Such measures are bound to win support from core Labour voters and were clearly meant to pacify any criticism from TUC members when Brown moved onto the thorny issue of the day — namely spending cuts.

Not that he needed to bother of course. When it came to addressing the need for cuts all he had to say was;-

“Labour will cut costs, cut inefficiencies, cut unnecessary programmes and cut lower priority budgets. But when our plans are published in the coming months people will see that Labour will not support cuts in the vital front line services on which people depend….

I say when we came in in 1997 we faced huge constraints to get the debt down, and we chose the right priorities; we created the minimum wage , created sure start for children improved schools immediately ended the neglect of the NHS and created the new deal that has helped two million people . We did it because we chose the people’s priorities – each of us working towards realising the talents of all.”

So according to this logic the rich will be taxed, efficiencies will be found, services will be preserved, new programmes will be introduced and the debt will be reduced. Sounds great, doesn’t it?

My plan during the same period will be to start dating Megan Fox, playing upfront for Arsenal, attempting my first moon landing and single-handedly solving the Middle East Crisis. I won’t bore you with the details of how exactly I am going to achieve all this, but we obviously live in a World where plans don’t need details and boundaries are not defined by restrictions of resources.

Perhaps I am being unfair as we are yet to see Labour’s specific plans, but whatever they manage to produce selling Sterling in 2010 looks like a strategy bound to succeed.

10th September Greenspan talks of a future market crisis

I am a little bit behind in taking note of comments former Fed Chairman Alan Greenspan made earlier in the week. While he stopped short of directly accusing greed of being one of the root causes of the Credit Crisis, the main thrust of his argument seems well placed.

Although Greenspan was one of the main architects (culprits?) of the system which collapsed under negligent credit conditions, since leaving the Fed I can’t help but feel he has seen the error of his ways. While he is certainly accountable for a great deal, he was also an agent of society’s will. It is certainly true that he opened the credit flood gates but it was wider society that gourged itself on “cheap” credit paying for products and services we either couldn’t afford or didn’t need.

The more I reflect on what has happened the more I am coming to the conclusion that the system of capitalism has failed. It might not feel like that at the moment but I have a strong sense that substantial changes are around the corner. They have to be. We can’t carry on as we did before, but nor does it appear anyone has a clear vision of what will come next. While this is very exciting it is also equally terrifying.

Growth built on excessive borrowing is both unsustainable and unhealthy. High interest rates strangle the activity of overly leveraged consumers, corporations and governments. Given that very little has been done to address this fundamental problem, the situation will surely only get worse.

Sorry but I am still not buying into the recovery in 2010.

9th September The rally hits its 6 month birthday

Markets bottomed on March 9th. Since then the S&P 500 has powered forward 52.7%, having recently broken the 1,000 level. Given the S&P 500′s preeminence amongst global equity indices, we can use it as a proxi. On this basis any pessimism about the rest of the year could look misplaced. Let the good times role!

Or maybe not…

Further analysis of the rally in the S&P 500 reveals some interesting facts. If we look at some of the closing prices, the S&P 500 bottomed on March 9th at 676.53 and today’s close of 1,033.37 represents the rally’s peak. This makes a total move of 356.84 points in 6 months.

However of this 356.84 point move, 252.7 points (70% of the total rally) occurred within the first two months when the S&P 5oo closed at 929.23 on May 8th. The index then moved sideways in a 65 point range for a further two months until July 10th, before it resumed its upward momentum taking us to today’s close.

So what has driven this stock market rally?

The initial sharp rebound in the S&P 500 is relatively easy to interpret (though not so easy to have predicted!), given how severe the selling had been from September 2008 to the March low. The highly emotional state of markets, the decline in valuations and numerous announcements about global fiscal stimulus all combined to catalyse one of the most intense periods of buying in stock market history.

After such a run up the fact that the S&P 500 effectively paused for two months was also not too surprising. It might have been fair to expect more selling during this period, but as I said at the time the weight of the move was definitely to the upside.

Events since July 10th though require a bit more thought. Looking back now I am sure that earnings season (from mid-late July to early August) helps explain the latest stage of the rally. I wrote at the time, and also more recently, that earnings will have to start to determine stock prices at some point. However I think now I have jumped the gun slightly in calling this too early.

The last set of corporate results were not disastrous, but they were also a long way from being decent. In fact it could be argued that results were so bad that they have driven up the premium investors have to pay to own stocks. As prices rose and earnings dropped Price/Earnings ratios were bound to rise sharply. I picked up on this last week when I wrote that P/E ratios in the FTSE 100 are now above 25 (sorry I can’t find the same figures for the S&P 500, but I believe anecdotally that they are currently at about 21 — please correct me if I am wrong about this).

So faced with the evidence that markets have been able to shake of pretty unfavourable earnings, what is clear now is that it is not earnings themselves that have driven up stock prices in the last two months, but rather improved expectations.

So there is no surprise there you might say, but there will come a point when investors pay far more attention to how healthy companies’ bottom lines and balances are. Herein lies the fundamental problem facing markets at the moment. When valuations are not based on actual performance but emotional reactions to news flow history has shown us time and again that corrections are painful and pronounced.

The next set of results and updates on expectations in 2010 are due from late October. I think this will be a time for us all to hold our breath.

3rd September Now the OECD believes the recovery will start sooner than expected

I caught an interesting news item today, which declared that the Organisation for Economic Co-Operation and Development (OECD) now believes that economic recovery is around the corner. I am still highly sceptical of this view as I just can’t see how anyone can make such a prediction with any confidence until we have had at least 6 months of life with fiscal stimulus.

While I don’t doubt I could be wrong, there was one aspect of the OECD’s announcement that I agreed with wholeheartedly; namely that the UK will miss the start of any upturn. There really can’t be any argument that the true health of our beleaguered economy cannot be judged until after the next General Election.

I feel like I have made this point over and over again, but until we feel the affects of public sector spending cuts and increased taxation to pay down the National Debt we are in a state of economic limbo. While there has been some renewed noise about curtailing bankers’ bonuses, I still can’t point to any drastic new measures which have been introduced to restructure the economy. Quantitative Easing, while drastic, was merely designed to prop up the old regime.

Forgetting about the sagacity of QE for the moment, there was another news item on Tuesday, which highlights the dilema we will be forced to resolve in the coming years. According to the Bank of England, UK consumer debt fell for the first time since 1993 to £1.457 trillion. This in itself has to be a healthy thing for the economy in the long run, but the coverage and analysis of this news was very telling.

The prevailing view seemed to be that this news highlighted the failure of Government policy in dealing with the Credit Crisis. There is a certain logic to this . When we consider the various policy responses to cope with the downturn, they have almost exclusively been aimed at freeing up credit markets. Tuesday’s news was, however, categorical evidence that net borrowing (and therefore lending) has fallen.

This is very worrying for the short and medium term outlook as it looks like we are all about to discover the hard way that increasing borrowing to resolve a debt-driven crisis is a fundamentally flawed strategy.

2nd September The bear takes a swipe at markets

One hour before the close of European markets on Monday there was a large sell-off. While volume was notably higher than the last two months, it wasn’t catastrophic. I held off writing a blog about this until today as I wanted to see how markets reacted.

A severe, follow-through sell-off today would have indicated the likelihood of much more selling to come. However this didn’t happen. Volume has been light in Europe and the US and markets slipped slightly.

The US Payrolls Data is out on Friday and the recent trend for this has shown a deceleration in the deterioration of the American labour market. This might well give some temporary support to markets for the remainder of the week, but I am going to sell any move to the upside from here.

No matter how you look at it equities are over-priced at the moment. I haven’t talked about earnings for a while but I caught an interesting news item about the recent spike in price/earnings ratios. In the UK, stocks of the FTSE 100 bottomed with a p/e of 2.9 in October 2008. As of Friday evening the p/e had risen to 25! Yes that’s right 25.

In other words, based on current dividend payments, you, as an investor, are expected to wait 25 years to turn a profit on every £1 you invest. That is quite a hefty premium considering the current outlook and general climate of risk.

I wrote about the importance of earnings at the start of the summer and it seems that this factor might be starting to creep back into market sentiment. I am still convinced that the current rally has been driven largely by the fiscal stimulus measures, which are now coming to an end. Of course this money will have a prolonged affect, given the amount that was issued, but basic fundamentals are going to have to start having more of an impact at some point. While the latest earnings season wasn’t the disaster I half-expected, it was still pretty terrible. To my mind the outlook is still not that much better.

But focusing on the likely action in the next couple of months market technicians are now talking of a Fibonacci retracement. I will spare you the details, but according to this popular method of predicting market movements we are likely to witness a pullback in stocks until September 25th. From this point the rally will resume, make a new high and then we will see a more severe correction.

I am going to spend some time working on charts tomorrow and Friday, to set myself some price targets. September is really shaping up to be an exciting month!