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June 2009 Market Review

Posted by Larry Doyle on July 1, 2009 8:52 AM |

A cursory review of market returns for June indicates no dramatic shifts, so let’s go to the sports pages, right? No, don’t do that! In the Brave New World of the Uncle Sam economy, every day, week, and month provides historic developments both above and below the surface.  How does one possibly navigate the hills and valleys of the markets and economic landscape? Welcome to Sense on Cents!

I had forecasted in the Sense on Cents May 2009 Market Review:

Add it all up and I think the following will occur:
– equity markets will now move sideways in range bound fashion;
– the bond market will move lower in price, higher in rates;
– the dollar will gradually decline;
– our economy will be filled with more stops than starts.

Let’s review the stat sheet, assess our May calls, and forecast what we see on the horizon. As we move along, let’s continually remember the largest player in our markets – both literally and figuratively – is none other than Uncle Sam himself.

Pimco’s Bill Gross said a few month’s back, “you should keep the big uncle in clear sight and without back turned.” The Wall Street Journal reported just yesterday in Inflation Fears Seem to Be, Well, Inflated:

Given the Fed’s heavy and unpredictable hand in the market lately…

Yes, Uncle Sam is casting an ever larger shadow across our economy and markets. Let’s navigate . . .


Market Returns:

Equities: the major market averages (the DJIA and S&P 500 especially) ended the month largely unchanged. In fact, the S&P 500 ended the month exactly unchanged. That said, the markets had an overall range of approximately 6%-7%. Why so volatile? Primarily a continuation of technical flows of funds, while the economic fundamentals remain decidedly mixed.

The tech heavy Nasdaq continued to outperform given some positive earnings developments (e.g Oracle) and lessened debt burdens. Given the Nasdaq’s dramatic outperformance, I would be reluctant to add exposure to this sector.

Sense on Cents’ self-assessment of May call: very solid

Bonds: while the 10yr Treasury ended largely unchanged on the month, it experienced a major selloff and actually broke above the 4% level for a short stretch mid-month. The upward pressure in rates, about which Sense on Cents wrote extensively, raised major concerns about potential inflation, economic recovery, and the equity markets.

Rates came back down over the last week. Cooler heads prevailed, right? Or did that “heavy and unpredictable hand of the Fed” go to work? Sense on Cents feels strongly that the Fed managed to move rates lower via quantitative easing and working with Treasury which had redefined indirect buying in Treasury auctions (“Turbo-Tim Takes ‘Indirect’ to a Whole New Level”).

While the government bond sector did post slightly negative returns for the month, the credit sensitive sectors of the bond market (corporates, high yield, municipals, and mortgages) did post low single digit returns. What is driving cash into these sectors? The fact that the Fed and banking system at large are holding short term rates (including savings rates and CDs) at near zero or marginally above is literally compelling both consumers and investors to seek some degree of return elsewhere. That money is flowing into these bond funds as investors remain extremely concerned about the economy and equity markets.

Are investors being lured into a potential trap by investing in bonds? I believe they are. I do not see the pressure of global government deficits along with refinancing pressures throughout the economy abating anytime soon.

Sense on Cents’ self-assessment of May call: fair

Currencies: the dollar remained in a fairly narrow range and ended the month slightly positive against the Japanese yen and the Euro. Although the price action did not reflect it, there is a major undercurrent at work in the currency markets. That current is reflected in ongoing calls by BRIC nations for a move away from the U.S. dollar as the international reserve currency.

The tremendous depth of currency markets overall typically precludes major moves in the largest currencies, such as the U.S. dollar, in rapid fire fashion. That said, I do believe the greenback will likely decline in value over time given the ever increasing debt/GDP ratio in our country.

Sense on Cents’ self-assessment of May call: poor

Commodities: the Dow Jones-UBS Commodity Index declined approximately 5% over the course of the month. This index is up approximately 10% over the last three months. Not all commodities are fully correlated. Oil was up 5% on the month, natural gas was down approximately 12%, corn was down approximately 20% (!!!), metals, including copper and gold, were down 2-5%.

The Baltic Dry Index (BDI) has retreated recently but has nearly doubled over the last three months. In my estimation, much of the movement in metals and in the BDI is driven more so by activity in and out of China than in the United States.

Oil remains the real wild card amongst all commodities. Oil and natural gas had a major disconnect this month. Supply figures for oil are high, but the price does not reflect it. Is the oil market pricing in an expectation that the United States will pass the cap and trade legislation prompting an increase in oil imports? Perhaps.

Economic Review: Sense on Cents would like to forecast a rebound in our economy, but I do not see it. In fact, while market analysts and government officials would have us continue to view the economy from the perspective of the rear view mirror, I feel strongly that we need to continue to redefine the economic inputs so we can properly assess the economic output. For example, I no longer see ‘unemployment’ as a lagging indicator and wrote as much in my post, “Why the Economy Isn’t Improving Anytime Soon”.

For the most part, I view positive economic signs as the result of government props while the real fundamentals in our economy continue to struggle to adjust to the lack of credit which had been provided by our shadow banking system. Again, recall that the shadow banking system (the Wall Street securitization model), which is currently barely operational, had provided 40-45% of the total credit in our economy.

Economic statistics reported as ‘less bad’ on a month to month basis do not mean they are going to start to turn decidedly positive.

Delinquency statistics in housing and credit cards continue to increase which will flow through our banking system and curtail any real improvement in consumer spending.

We all need to adjust to an economy with significantly lessened demand across the board.

Sense on Cents’ self-assessment of May call: solid

The Path Forward: Uncle Sam has decided throughout this ordeal to buy ‘time’ in an attempt to let the economy heal versus quickly flushing losses through the system. While we mark ‘time’ as evidenced by the June market returns, the losses in our economy at large and financial system specifically remain. A large percentage of those losses reside within our insurance companies (specifically in commercial real estate), Freddie Mac and Fannie Mae, and the Federal Home Loan Bank system.

The ongoing increase in delinquencies and foreclosures across all credit products will serve as “death by a thousand cuts.” At this juncture, no single cut will be fatal but the overall ‘quality of life’ for our economy, and in turn our markets, will be mediocre at best.

I repeat my May calls.

I do believe that Uncle Sam will be worn down little by little over time. As such, interest rates will move higher capping our equity markets.


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