Markets Moving Higher - Traders Reading Improving Economic Conditions Into Tea Leaves

March 19, 2010 – Stocks are moving higher again this morning, as traders look to improving conditions in global economies as being a positive signal for future earnings.

The dollar is stronger against the euro this morning, with the euro trading at $1.3550. The primary factor in this equation is renewed weakness in the euro based on concerns about the Greek debt issue and whether EU countries will come up with a plan to help, or whether the IMF will step in.

Gold prices are down $2.50 this morning to $1,125. Look for relative strength in the dollar as being the primary factor here. We remain bullish on gold and bearish on the dollar, pointing the U.S. balance sheet and very distinct possibility that the U.S. may back ratings companies into a corner with respect to the ratings of its own debt, as its national debt heads towards $13 trillion and we approach yet another debt ceiling.

Oil prices are down $0.33 this morning to $81.87, which is a little surprising given that the theme in other markets is global recovery. That would typically be a bullish signal for oil demand. A stronger dollar is being attributed as the primary catalyst. The Energy Department reported an increase to 344 million barrels yesterday, while it said fuel demand declined 4.2% to 18.8 million barrels/day – not exactly a signal here in the U.S., of economic strength.

In terms of what we expect in today’s session, stocks are moving higher, regardless of how Kool-Aid-driven the rationale is. We noted at the outset that today’s theme is largely centered around the notion that earnings outlooks are improving amidst strengthening conditions in the global economy. That makes enough sense, but keep in mind that this isn’t exactly as windfall prognosis for U.S. based companies, where exports represent only 11% or so of GDP. There is probably more substance to other implications of a strengthening global economy:

·         More leverage against the U.S. (coming primarily from China, its largest debt purchaser)

·         The ability for foreign businesses to invest more in resources and inventories to sell their goods to U.S. consumers

The bottom line that this economy still relies heavily on its own consumers to spend more than 90% of their disposable income to prop up their 70% share of GDP. And while, thankfully, the economic data here in the U.S. has generally gotten ‘less bad’, it is still dismal and doesn’t, in our opinion rationalize the current levels of valuations that we are seeing in stocks.

The big concern we have is the employment sector, which is being marginalized by many pundits who talk about a ‘jobless recovery’ as if that is even possible.

To be sure, the massive amounts of stimulus has definitely offset the negative impact of more than 8 million people being out of work (some folks like David Tice – see below – use an 11 million number). But stimulus spending is not a viable long-term strategy. It is a very short-term emergency plan. We just see way too much risk, systemically built into the U.S. economy and don’t buy into the rally (to be fair, we have been bearish for the last 1000 points or so rise in the DJIA).

As much as capital appreciation, we are focused on capital preservation, and to that end, we have been advocates of hedging strategies like writing out of the money covered calls and selling puts on stocks you would like to own at lower levels into market weakness. The derivative strategies mentioned above can often turn out to be interesting trades in  themselves (see other commentary on this website). We are also advocates of accumulating more gold on dips, and keeping a healthy store of cash available to take advantage of that pullback which we see as inevitable.

Wit, Wisdom, Fools and Folly

David Tice, of Bear Market Strategists told Bloomberg he thinks the secular bear market won’t bottom until we get back near, or below book value. Asked about signals that the economy is strengthening, he pointed to employment .While claims were a little less than expected, continuing claims were higher. Extended benefits were 350,000 above expectations. We have 11 million people out of work including 6 million on the extended benefits plans.

Asked about ‘reasonably priced’ blue chip stocks. He said very few strategists saw the recession coming back in 2008. He said he believes that buying into the Keynesian theory of pouring $3 trillion into the economy is having little impact.

In terms of what Tice is bullish on – gold, which he believes represents stability over the long-haul.

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