Economic & Market Update: August 31, 2009

“So Long Sweet Summer”

The Fortigent Investment Research Team

http://www.Fortigent.com

Last Week’s Highlights:

Economics This Week:

Date      Item                                                Est.                     Comment

9/1        ISM Index:              50.2                    Higher auto production likely to help

9/1        Construction Spending: -0.2%    Inventory overhang drags on spending

9/2        Factory Orders:                    1.5%    Expected to increase off poor levels

9/4        Nonfarm Payrolls:            -225K    Employees still facing headwinds

9/4        Unemployment Rate:        9.5%     Stable on diminishing workforce

Tepid Week for Investors

It was a mostly sluggish week for equity markets with investors finding little positive or negative news to latch on to.  The S&P 500 index ultimately finished higher by 0.3%.   

The biggest story of the week was the nomination of Ben Bernanke to a second term as Federal Reserve Chairman.  Although Bernanke may not have been a consensus favorite among market pontificators, his reappointment at least provides clarity on the future direction of monetary policy. 

Also of note, the number of failed banks continues to increase, on the heels of bank takeovers in Maryland, California and Minnesota.  The Federal Deposit Insurance Corp’s (FDIC) release of the Quarterly Banking Profile showed that the Deposit Insurance Fund fell to $10 billion, from more than $50 billion in March 2008.  The Wall Street Journal is also reporting that the FDIC is potentially on the hook for more than $80 billion in losses on loans and other assets.  In an effort to attract new investors, the FDIC relaxed rules regarding the ability of private equity investors to purchase failed banks.  While the new rules are unlikely to create an influx of private equity money into the banking industry, it should help to provide additional capital for the distressed banking sector. 

Treasury auctions were mixed during the week with poor demand at the 2-year auction early in the week followed by a record setting 7-year auction on Thursday.  The $28 billion auction was one of the largest of the year and showed a bid-to-cover ratio of 2.74, relative to a 2.44 average in the previous six auctions.  Indirect bidders, which include overseas central banks, snapped up more than 60% of the supply, suggesting that demand among our overseas counterparts has yet to wane. 

The Fall May Not Be So Great After All

In 1922, T.S. Eliot famously wrote that “April is the cruelest month...”  He was obviously not referring to the stock market, and luckily for Mr. Eliot he stuck to a life of penmanship, as he would have been a most unprofitable investor given that motto.  It turns out that September is actually the year’s cruelest month for the equity markets. 

Source: Bespoke Investment Group

Reasons behind September’s malaise run the gamut from seasonal affective disorder to plain old bad luck, but regardless of reason, the data supports the idea that investors should be cautious heading into the fall season.

Similar to early March, when outspoken strategists such as Steve Leuthold called for a market bottom, strategists are now calling for a market slowdown (see: Doug Kass and David Rosenberg) which may lend support to the ‘September effect’ this year.

In the end, does this represent sound invest advice?  Of course not – correlation does not necessarily imply causation.  Case in point, earlier this year, investors who bought into the ‘sell in May and go away’ rule missed out on a nearly 15% rally in the S&P 500.

Longer term, the picture is equally as muddy.  Morgan Stanley looked at 19 secular bear markets around the globe and found that the average rally during a secular bear is 71% from the bottom over a span of 17 months.  This is followed by a 25% correction and then an ensuing broad trading range for 5.6 years.  In 12 of the 18 equity bear markets studied, the reason behind the correction was a change in the interest rate cycle.  A hike in the Fed funds rate in late 2010 or early 2011, as expected, may be the next catalyst for broad equity market weakness.  Market participants are currently pricing in a 25bps hike in the Fed funds rate by early 2010. 

Source: Morgan Stanley Europe; The Big Picture

April, by the way, is one of the best months...for stocks, at least.

Government Printers Mysteriously Running Out of Red Ink Cartridges

Last Tuesday the Congressional Budget Office (CBO) and Office of Management and Budget (OMB) released updates to their respective budget outlooks and no matter how you split the data it is rather startling.  The OMB’s near term picture improved slightly (the deficit is now expected to stand at 11.2% of GDP rather than 12.9% for fiscal year ‘09) but the long term outlook is nasty. 

Source: The Economist

The OMB sees federal debt hitting 77% of GDP in 2019, up from 41% last year, while the average deficit will run about 5% per annum in the next decade.  This leads to a 10-year federal deficit of $9 trillion, a total greater than all previous deficits since this country was founded.  The CBO maintains a more optimistic outlook ($7 trillion over 10-year’s) but this is primarily due to their figures factoring in the expiration of the Bush tax cuts in 2011, an idea that Obama promises to keep for families making less than $250,000 a year.  

Naturally, outlooks of this nature are difficult to rely on given the ever changing economic landscape, but they do provide a baseline scenario to operate off of.  The current healthcare debate also leaves the possibility of rendering these numbers completely useless.

The Week Ahead

This week brings a host of important economic indicators from the ISM report on Monday to Friday’s employment report.  It should be a seasonally quiet week with holidays in London and an impending long weekend in the US sending investors away from their Bloomberg terminals. 

On Thursday, the European Central Bank will meet to discuss interest rates.  It is not expected that the group will raise rates, but a more optimistic economic outlook could buoy the markets. 

The G20 finance ministers will meet on Friday and Saturday in London prior to the G20 summit later in September.  The focus will be on the state of the global economy with a possible discussion on exit strategies on the table. 

Quotable:         “Ninety-nine percent of the people in the world are fools and the rest of us are in great danger of contagion.”  Thornton Wilder, American author and playwright

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