06/24/09   Looking More Like an L

Editor’s Corner

Looking More Like an L

Ron Rowland

Recently we read about an economist who was asked why the members of his profession continue making forecasts when they are so frequently wrong. His answer: “Because you people keep asking us.” Indeed, investors often pay inordinate attention to questionable data and forecasts simply because they have nothing better. Consider the odd reaction on Monday of this week to news that the World Bank was projecting global GDP to decline by -2.9% this year. This bad news made world markets tumble, but in fact, it wasn’t “news” at all. The World Bank released the estimate on June 11. As far as we can tell, only a few bloggers noticed it until Bloomberg picked up the story on June 22. From there it becomes a chicken-and-egg question: did markets really fall because of the report, or was the report a convenient culprit for reporters who needed to explain an apparent trend change? We may never know.

We should note that other agencies like the IMF (International Monetary Fund) and OECD (Organisation for Economic Co-operation and Development) don’t necessarily agree with the World Bank’s forecast, but there does seem to be a growing loss of confidence in the “green shoots” of economic recovery. We are in the midst of a particularly data-rich week. Reports on the sales of new and existing homes suggest the housing market is stabilizing somewhat, but there is no sign of a recovery to significantly higher prices. The main thing we have learned is that discounting works. The huge inventory overhang may keep a cap on prices for a long time. Likewise, today’s release on Durable Goods Orders hinted at stabilization in the industrial sector but not a return to prior levels. The economic recovery pattern looks more and more like an “L” shape and less like a “V” bottom.

The Federal Reserve’s Open Market Committee kept short-term interest rates unchanged today. More important, the FOMC left the previously announced $1.75 trillion bond-purchase program in place and said it expects “inflation will remain subdued for some time.” If the combination of those two points seems a little jarring, you’ve noticed something important. The Fed is, after all, using its balance sheet to create inflationary pressure. They are getting away with it, for now, because the economy is so weak and asset prices are in the basement. The FOMC further said it expects to keep overnight rates at “exceptionally low levels” (i.e., near-zero) for an “extended period.” In the long run, the result of this zero interest rate policy (ZIRP) almost has to be inflationary, but the long run can be a long time.

Earlier in the week, the Treasury managed to sell four-week, three-month, and six-month T-bills along with two-year and five-year notes on generally favorable terms, though the pattern continues to be weaker demand as the maturity lengthens. Major buyers – by which we mean “China” – are clearly trying to reduce the duration of their Treasury portfolios. The ten-year yield touched 3.58%, its lowest point since June 3, and we won’t be surprised if this low holds for some time. The interest rate trend is clearly pointed higher for all but the shortest maturities.

Sectors

Last week we predicted that Technology would take over the top spot in our sector rankings from Materials, but we failed to appreciate how drastic a change was in store. Materials fell all the way down to sixth place while Technology is #1 by a wide margin. Technology has not really advanced much this month; it has simply held relatively stable while other sectors have faltered. Utilities made a big leap to take the #2 spot while Health Care jumped from last place to fourth on the list. Energy now has negative intermediate-term momentum and we could easily see half the sectors flip to red by next week.

Styles

Stratification in the Style rankings is very clear: Growth, then Blend, then Value. Small Cap Growth and Micro Cap are on the top while Small Cap Value and Large Cap Value are on the bottom. Most Style categories are in the process of rolling over, and it is critical they find support at their May low points if the rally is to continue. Many Style categories are in jeopardy of turning negative very soon.

International

The frothiness in the Global rankings at the beginning of June has now corrected itself. Intermediate-term momentum still favors emerging markets over developed ones, but that is changing quickly. The U.K and Japan, both of which were in the basement not too long ago, are climbing the rankings and are now in the upper half. The USA is still in last place.


Note:

The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.


“Time is really the only capital that any human being has and the thing that he can least afford to waste or lose.”

Thomas Edison


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