Connect the dots 6-10-09: Part I

Our weekly Connect the dots. Let’s look at the market performance over the past week, month, quarter, year on an absolute level and a relative return level.

We’re going to start the weekend with our weekly market monitors.

Market Monitor



What do we have here? This year is full of stress, but looking at the broad averages, the S&P is down slightly. What a ride!? So what do we see when we look deeper?…

Commodities (ex natural gas), emerging markets, and tech certainly pop out. Interestingly, I’m not sure they are telling the same story. Tech tends to be low debt companies. Earlier today Goldman even upgraded Dell and hinted that investors should revisit tech. Companies would be pulling back on some tech investing in the current environment, except…Except for productivity enhancing tech or cost saving tech. Remember, a lot of companies still have cash on their balance sheet from a year of decreased transactions. Stock buy-backs and dividends aren’t where the companies want to spend their cash because re-issuing shares down the line seems questionable at this stage. Large acquisitions are out of the question. So, what’s left?

Commodity related industries tend to be capital intensive and they’re certainly levered to any growth. Yet, in an environment like this, growth assumptions are low or negative for most of the world, so I doubt that the argument holds. Instead, maybe the answer lies in the expectation that inventories need to be rebuilt. Over the past 18 months, despite the consumer slowdown, production levels decreased even faster and inventories have shrunk to the point where any pickup could send producers scrambling. Who’s facing the shortest inventory? Not surprisingly, our old auto industry is front and center. Once again, the US auto manufacturers are going to get caught flat-footed. They’ll finally face a little bit of demand, but not enough capacity will be on line and commodity prices will have gotten away from them.

Anyway, TBT continues to grind lower and any “investors” left in it, should see some of our previous postings on levered ETF’s. It will slowly grind away at your returns, even if the direction is correct. (I do not own TBT nor do I own it in client accounts.) I’ll speak more about the bonds complex next week, but I have to admit that everyone and their brother is telling me about bonds with equity like returns, but sitting at the top of the capital structure. I think the “easy money” of buying solid bonds at 60 to 70 cents on the dollar is gone. Now you’re in for a grind with the smartest guys in the room. Maybe that 8-9% yield on a BBB credit is OK given that Treasuries are paying 3%, but when Treasuries go to 6% (not a far stretch) these will go down much farther and much faster. Do you really think the yield will go down? So you’re clipping a nice coupon, which is well and good as long as they pay, but if California can default so can that from AA company. And if you think the economy will improve, better to get the leverage in the equity. It’s probably at decade lows (using a representative BBB company).

Barron’s has mentioned it. The Big Picture has mentioned it. So you should at least be aware of it. Last year, Rogoff and Reinhart wrote an analysis of financial crises and the impacts on different asset classes: Aftermath. The basic conclusion: in the aftermath of a financial crisis, asset classes show higher correlation and there are very few places to park. Equities and real estate and bonds and whatever all face severe headwinds. All of that was to say, watch out for the 8% bonds. It might just be a trap.